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After yesterday's massive moves in risk assets it is no wonder that markets have had a more muted start to the day. The pan European index is slightly weaker after a stunning 4.3% rally yesterday. The broad based rally was on the scale of March 2009 moves, but while we think risk could rally into year-end, there are many pitfalls ahead.


· The coordinated central bank action continues to dominate headlines, but after yesterday's unabridged glee at the liquidity splurge by the world's most important bankers today the markets are digesting the move and are looking ahead to what it may signal. There are a few unanswered questions: 1, Will this spur the European high command to take bold long-term action at the EU summit next week? 2, why is the Fed allowing European banks to borrow dollars at a cheaper rate than US banks can borrow dollars? 3, While European banks need access to dollars to fund sizable dollar-based assets, what about their access to euros?

· The Euribor- Eonia spread has surged in recent weeks from 30 basis points in October to 80 today, which suggests stresses in Europe's money markets are at elevated levels. Since European banks need euros to cover the enormous amount of Eurozone sovereign debt on their books this is not a good sign. So essentially you could say that yesterday's move solved one of the problems, but there are still many other issues that need addressing. We still need Europe's political high command to deal with the sovereign issues; otherwise the banks will remain stuck in a rut.

· The markets have become so addicted to risk, just like any other addict eventually one hit is not enough. Hence yesterday's rally hasn't been sustained today. We need to see what the EU summit comes up with next week since central banks alone can't solve this crisis.

· So if bold action is not forthcoming then expect risk to drift off, but this time there most likely won't be a massive liquidity injection to get things moving again.

· The weaker tone to risky assets hasn't been helped by ECB President Mario Draghi who is speaking at the European Parliament in Brussels today. He effectively ruled out a lender-of-last resort role for the ECB by saying that its bond purchases can only be temporary in nature. Instead he urged for closer fiscal union. This suggests that next week's summit will work on fiscal unity or as Draghi said the anchor in the long-term rather than alleviate the solution by allowing the ECB to buy sovereign debt and bring Italian bond yields back below 6%. Draghi said that this should improve confidence in the short-term, but will it? Will the markets trust that the EU can push through fiscal unity and stabilise the markets before Italy tries to auction EUR 300 BN of debt next year? This seems unlikely to me. Central banks have provided the short-term fix, EU politicians are working on the long-term fix, but what about a medium-term measure to stabilise sovereigns while fiscal unity is thrashed out in Brussels? This is the important piece of the jigsaw that is missing and is keeping markets volatile.

· However, there has been a broad-based recovery in the European bond markets. Italian bond yields have started to moderate today and are back below 7% at 6.99% the lowest level for 2-weeks. It seems like yesterday's liquidity injection has boosted confidence that sovereign concerns will be addressed in the near-term, even if it isn't the be-all and end-all answer to this crisis.

· Elsewhere, we have the slew of usual economic data at the start of the month. Interestingly, US manufacturing data is expected to surge ahead of Europe and China, which should be good for US stocks.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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