Sunday, September 18, 2011

Five world markets themes in the week ahead

Following are five big themes likely to dominate thinking of investors and traders in the coming week, starting Monday, Sept 19 and the Reuters stories related to them.


Global investors will in the coming week have the Fed's two-day meeting to distract them from the euro zone. There is a growing assumption that the U.S. central bank will deliver another version of "Operation Twist" - a program intended to drive down long-term interest rates. Coming on the heels of the Fed's pledge to keep rates low at least until mid-2013, this may offer some support for global stocks, which have barely lifted off lows hit in July on fears of recession and debt problems on both sides of the Atlantic. Equity valuations may be cheap but stocks could cheapen further still given there is no sign of an end to the euro zone debt crisis and a Reuters global poll shows an increase in the perceived risk of recession in developed countries. If the Fed does opt to twist again, G7 government bond curves will flatten.


Euro zone banks were already finding it costly to obtain dollar funds in the money markets. Given lenders typically hoard cash in the run-up to the end of the quarter and of the year to spruce up their books, it can only help that the ECB has reintroduced three-month dollar liquidity operations in coordination with other major central banks. The coming weeks will show whether this is enough to sustainably ease the money market stress that was being flagged by cross currency basis swaps and other prices. Nomura says that while FRA/OIS spreads are showing funding problems are far more focused in the European banking system than was the case in 2008, a steeper dollar FRA/OIS curve suggests there is an increased risk of future stress in the U.S. financial system. It is therefore little wonder that concern about Europe's sovereign debt crisis is evident at the highest levels in the United States.


The unprecedented move by a U.S. Treasury Secretary to attend this week's informal meeting of EU finance ministers in Poland raised market expectations, particularly given there appears to be openness in some EU capitals to the idea of a U.S. TALF-like leveraging of Europe's bailout funds. Rhetoric alone won't be enough to appease investors' nervousness, particularly given credit and secondary bond market prices are implying the near certainty of a Greek default that goes well beyond the scope of the private sector involvement plan already under way. Investor sentiment will also take a knock if the European Commission's plan to lay out options for euro bonds continues to encounter such strong opposition that it becomes a non-starter. And last but not least, the slow progress in ratifying the EFSF country by country is being closely monitored - delays or rejections would imperil the plan to transfer bond buying powers from the ECB and to allow it to support banks.


European banks already face challenges in raising capital to deal with any further write-offs that they might suffer on their peripheral exposure. Any "disorderly" default by Greece would suck other euro zone sovereigns (notably Italy and even France) into the debt crisis, wreak havoc on the European financial system, and make it well nigh impossible for banks to raise funds in the market. Shares in European banks are still 56 percent lower than they were before the collapse of Lehman Brothers three years ago. Few are willing to view valuations as supportive, even though the 12-month forward P/E ratio for the STOXX Europe 600 banking index is at its lowest ever, 5.73. That's because analysts are continuing to cut their earnings estimates for financial institutions, with some even going into negative territory, making forward P/E less useful as a compass for investors.


Financial market interest in the coming week's BRICS meeting is running high given speculation over what these emerging market powers might be willing to do - as a group or individually - to help out the euro zone by buying southern European sovereign bonds. Barring any sign of such interest, the euro could find itself extending losses. The single currency faces drags from the broad trend of a narrowing U.S./German two-year spread, a shift in market expectations of ECB policy, as well as the various sovereign and financial sector problems that make up the euro zone crisis. A protracted euro slide, especially against the yen, raises the risk of intervention by Tokyo, especially as the Japanese half-year draws closer. Sterling will be the other currency in the spotlight in the coming week as BOE minutes will show how many MPC members have swung in favor of another round of quantitative easing.

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