IG Markets Afternoon thoughts

IG Markets Afternoon thoughts

Across Asia, regional markets are weaker on concerns about European sovereign yields. Despite some positive US leads, markets have turned negative on persistent eurozone debt issues. The Hang Seng has dropped 1.6%, the Shanghai is 1.2% lower and the Nikkei is down 0.1%.

Australia's S&P/ASX 200 index is down 0.5% at 4266. The index fell to 4253.7 amid a lack of follow-through buying after rising to 4307.5 following a 0.5% rise in the S&P 500. Volume has been very light, with less than $800 million traded in the first hour. We were expecting moderate gains on the open following strong economic data in the US overnight. However, a lack of conviction by the bulls has once again seen the local market give up early gains. Investors remain cautious amid spiking European debt yields. The focus is turning to Spain and France after their yields spiked overnight. Iron ore miners are outperforming, with BHP Billiton flat and Rio Tinto up 0.7%. The banks are underperforming, with Commonwealth Bank down 1% after Citi downgraded it to sell. Some of the worst performing sectors are energy, infotech and utilities.

There has been some talk around the floors today that perhaps we may actually start seeing a slight decoupling of risk assets. Over the last year and a half, we have seen a clear ‘risk on, risk off’ trade, where positive data or sentiment has seen buying in equities, risk forex, commodities and the selling of US treasuries and bunds. Last night, solid US retail sales and empire manufacturing data, mixed with news later that Italian Prime Minister designate Mario Monti announced that the pieces appeared to be in place for a new government, saw the S&P rally 1.6% from a session low to high, while EUR/USD could only muster a 60 point rally. Clearly the European bond market is driving forex traders’ thinking right now, and with yields blowing out to record levels versus benchmark German bunds in France, Holland, Belgium and Spain, it seems that until we see this trend reverse the market will look to sell EUR/USD on any strength.

Interestingly, if one was to average out two-, five- and ten-year German bunds and subtract the same maturity of US treasuries (bund-treasury yield spread, where the lower the yield the less attractive the underlying currency), and overlap a chart of EUR/USD, it suggests fair value on the pair is around 1.30 at present; maybe the fundamentals will catch up and EUR/USD will gravitate down to these levels.

The market is concerned about Greece again, because the Greek conservatives seem hell-bent on causing further panic by saying that they would not bow to ‘dictates from Brussels’ over a bailout designed to save their country from bankruptcy and safeguard the euro. The Financial Times also reported that the private sector involvement for Greece is not going to plan, as it is requesting higher rates and potentially kickers if the Greek economy recovers. Greece has faded into the background a bit, given the contagion and recession fears in Europe, but until they get the sixth tranche of aid traders will remain on edge. The path of least resistance seems down at present, and while Europe seems to be heading for a recession in its periphery and perhaps the core, the US looks set to grow north of 3% in Q4. There is every possibility we could see EUR/USD break away from the ‘risk on, risk off’ trade, which has been evident for so long.

ENDS

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