The Bernanke-inspired risk rally from Friday has persisted as we start a new week. The story remains the same: investors are still clinging to the prospect of more QE at the September Fed meeting. Stocks in Europe missed out on Friday's rally so they are taking advantage of it today. The Eurostoxx 50 index is up by 1.57 per cent so far, although the pan-European index is still lower by nearly 20 per cent since the start of the year.
Although stocks are higher, credit markets are showing signs of stress. Italian and Spanish bond yields are back above 5 per cent, and Greek 2-year yields are currently more than 53 per cent. European problems are far from over, and September is jam-packed full of event risk for the currency bloc.
Firstly, Greece is set to receive its next tranche of bailout funds next month; however, Europe is still negotiating collateral terms in return for more bailout loans for Athens. The first collateral agreement was reached between Greece and Finland, today Finland's finance minister said that he is in talks to find a collateral model that all (of Europe) can approve and that the collateral issue should be resolved as soon as possible. However, if there is a delay with the next tranche of Greek funds because of collateral agreements then we may see a sharp risk reversal like we did in June, when financial markets worried about a possible disorderly Greek default.
On September 7 the German Parliament and Constitutional Court is set to rule on the legality of the bailouts and whether or not they threaten Germany's fiscal sovereignty. Without Germany's support the future of the Eurozone is thrown into doubt. German Chancellor Merkel has cancelled a trip to Russia to attend the vote, the outcome of which may have a serious impact on risk appetite.
During the weekend IMF Chief Christine Lagarde ruffled a few feathers when she said that Europe's banks need urgent re-capitalisation. Europe's top banks have criticised her saying that capital levels are not the problem; instead liquidity is what Europe's banks want. Europe's banks are having trouble accessing funding from their peers, especially dollar funding, which is why the Fed had to re-open swap lines (apparently for one bank only...). Added to this, Europe's banks have also been forced into secured lending - i.e., borrow against collateral, which signals a lack of confidence in the Eurozone's banking sector.
Largarde's comments are not unreasonable even though they have been re-buffed by Europe's high command. You could argue that there wouldn't be a confidence issue if Europe's banks were better capitalised. Right now Europe's most troubled sovereigns and a large part of the currency bloc's banking sector are reliant on liquidity and funding from the ECB and without its support Europe could find itself in an untenable position.
So why the contrast between credit and stock markets? As we mentioned above Europe's stock markets' performance over the course of the year remains weak, however the recent recovery is all down to the Fed and the prospect of further monetary support possibly as early as the September meeting. Later today the ECB will announce their bond purchases for last week, which is likely to remain consistent with recent weeks' purchases between EUR14BN and EUR20 BN.
EURUSD is back at the top of its range. After testing 1.4550, it is hovering around the 1.4500 zone. The euro tends to rise with other risk assets, but it also received a boost from ECB President Trichet who gave no indication that the 50 basis points of tightening so far this year would be reversed any time soon.
Elsewhere, Japan's ruling DPJ party elected Finance Minister Noda as head of the party after the resignation of Prime Minister Naoto Kan. Noda supports tax increases to fund the earthquake reconstruction programme and to reduce the enormous public debt, and is most likely to be favoured by the markets.
The yen continues to trade with a strong bias. There is now a clear divergence between the yen and the Swiss franc. Investors still won't fight the SNB and USDCHF and EURCHF are both significantly higher this morning. The political upheaval in Japan in recent days makes intervention less likely, which continues to attract flows into the yen.
Gold rallied along with stocks post Bernanke's speech on Friday and remains around the $1,820 mark, nearly $120 higher than the low reached on 25th August just above $1,700.
It appears that it is business as usual in New York, so expect some more activity when the US comes in. Personal income data, PCE data and the pending home sales along with a speech by the ECB's Trichet should keep the markets occupied this afternoon.
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Kathleen Brooks| Research Director UK EMEA | FOREX.com
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