18 Oct 2011 - Market Update

Details

Published on Tuesday, 18 October 2011 12:39

Sovereign debt concerns have moved beyond Greece as the market focuses on structural solutions to Europe’s debt crisis which threatens global growth.

Market pricing has rarely been so volatile with major equity indices enduring intraday fluctuations of 5%+ with alarming frequency.

A Greek default is now considered inevitable and the focus has shifted to managing the impact of this fallout amongst European Banks, and the knock-on effect this has on weaker sovereigns.  Dexia’s break-up and the concurrent increase in short term funding rates was eerily reminiscent of the final quarter of 2008 and as Dexia had just passed the bank stress tests earlier in the summer, this greatly increased pressure for an effective response to avert rising concerns about contagion.  European leaders have built up expectations of a broader, more comprehensive policy response at this weekend’s European summit but we expect that policy response will continue to evolve into 2012 and hopes of a ‘big bang’ solution are misplaced.  Focus will continually shift, most likely to the Cannes G20 summit in early November once this weekend’s summit concludes.  It is currently unclear if the political will required to make the treaty amendments demanded by the states with the most financial capacity to address these issues can be found.

Increasing expectations of a ‘quick fix’ from policy makers has led to sharp rallies of 10%+ across several major markets over the last two weeks.  Growth in the US continues to defy the best efforts of policymakers.  Weak numbers across leading indicators continue to reflect the challenge of recovery from the 2008 financial crisis.  Recent concerns about a slow down in China after providing much of the world’s growth since 2008 have abated somewhat.  Concerns about housing bubbles and domestic demand being insufficient to offset the slow down in exports meant CDS on China reached a high of 200bps in recent weeks (from 88bps at the end of July) though they have since tightened.

ABS

The European ABS recovered somewhat over recent weeks in line with equity market sentiment about sovereign debt.  The new issue market, in so far as it exists is almost exclusively focused on satisfying US dollar demand, with the $3.5bn Nationwide RMBS and Santander’s $3.5bn Holmes deals the most prominent – only the most defensive asset classes (autos, cards, UK / Dutch prime RMS) can currently access the market.  Senior ABS pricing remains more resilient than senior bank paper, though lower tranches have proven volatile.

Corporate

Quarter 3 was the worst so far of 2011 as all indices, led by financials and high yield, widened and funding conditions remained poor.  The final quarter has started stronger as some peripheral corporates priced deals and indices rallied in line with improving sovereign risk sentiment.  Earnings season in the US has started with the expected weak Bank results and though earnings will be closely watched, we look to macro sovereign news flow to set the tone for all markets.