IG Markets - Afternoon thoughts 30/11/11

Across Asia, regional markets are weaker after S&P reduced its credit ratings on several big banks in the United States and Europe on Tuesday as the result of a sweeping overhaul of its ratings criteria. The news saw US markets pull back into the close and erased all the gains we had seen in European markets overnight. Sentiment had been initially lifted by strong US consumer confidence data, which came in significantly ahead of expectations. Although S&P began warning the markets more than a year ago that it was revising its ratings, the announcement comes at a time when the markets for bank debts are fragile. The Shanghai is the worst performer in the region, down 2%. The Hang Seng is 1.3% lower and the Nikkei is down 1%. In light of the weakness we are witnessing in the region, we have seen US and European futures retreat after having posted gains overnight. As a result, US and European markets are now pointing towards losses on the open.

The Aussie market is outperforming the region, with a relatively flat reading after having headed lower early in reaction to the S&P changes. The news weighed on the financial sector, with most of the major banks losing ground early on. We have since seen a turnaround from this morning’s lows, with industrial names leading the charge. Data released later helped the market to recover some ground. The materials sector is underperforming, with BHP Billiton and Rio Tinto down around 1% each. Australian new capital expenditure growth surged 12.3% in the 3Q, beating an expected 7.0% increase. The rise comes as the full force of the mining boom becomes apparent in Australia. Locally, tomorrow’s session brings building approvals and retail sales data. Traders will also be looking out for China’s manufacturing PMI number, as well as HSBC’s final manufacturing PMI number.

Tonight’s US session sees ADP release its non-farm payrolls estimation, followed by pending home sales data. US data has been reasonably solid over the past couple of months, and while European debt concerns continue to dominate headlines, the US economy has been improving at a snail’s pace. Both pieces of data tonight will be seen as quite influential; it will give an insight into the two sectors that have offered the most stubborn resistance to improvement, so if we see some positivity in tonight's data we could see a good reaction in the markets. Traders will continue to monitor the situation in Europe closely, with this week’s bond auctions remaining the highlight. There is also a lot of economic announcements to look out for in Europe including a speech by ECB President Mario Draghi.

Despite a series of ratings downgrades to US banks from S&P risk FX seems to be holding up quite well in Asian trade. The EUR/USD is being supported on the news that European leaders are in agreement to applying leverage to the EFSF. Most of the details are in-line with what has been speculated on in recent weeks so the reaction in the forex market has been relatively muted. There hasn’t been a huge amount of news on additional funds to the IMF although eurogroup Chairman Mr Juncker suggested European nations would ‘rapidly explore’ increasing the IMF’s resources ‘through bilateral loans’ in order to match the increased firepower of the EFSF. It was positive to see the disbursement of the sixth loan tranche of aid to Greece which should keep them funded for another three months, with traders now firmly focused on the 50% write-down’s in January. Does the increase to the firepower of the EFSF change the market perception on Europe? Absolutely not, although it seems traders are giving European officials the benefit of the doubt that they can get something together to keep the euro together. The strength in the single currency can also be partly attributed to the huge level of net short positions in the market, with CFTC data suggesting there were 85,000 net short contracts as of last Tuesday, the most since June 2010. We feel EUR/USD is likely to consolidate ahead of the EU summit on December 9 where traders are now expecting something ‘game changing’ from officials designed to install confidence in the bond market. There are of course real risks and an article in the FT today titled ‘business planning for the end of the euro’ has been a sobering reminder of just how close we are to a pivotal moment for the single currency, that is why selling rallies around 1.3450 still makes sense to us in the short term.

ENDS

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