Saturday, October 8, 2011

Five big themes ahead for global economies

LONDON: Following are five big themes likely to dominate thinking of investors and traders in the coming week, starting Monday, Oct 10:


Global and regional economic forecasts are being slashed by many investment banks and some are even talking about a hard landing in China, which has been a key engine for growth in the past years. Lower growth forecasts are in turn feeding through to estimates for company

European and U.S. firms' earnings momentum has already suffered since the start of the year. Of course, many companies are sitting on large cash piles and some investors might view valuations as cheap.

That could explain why investors have been willing to buy equities without waiting for European policymakers to come up with concrete measures to back up their rhetoric on the urgent need to tackle the debt crisis.

Given the impact slowing economic activity will have on corporate profitability, euro zone politicians' ability to address the deepening debt crisis will be crucial if equity markets are to sustain bounces.


The root causes of the euro zone financial crisis require long-term solutions (e.g. euro bonds, closer economic governance, stricter oversight of national budgets), but there is an urgent need for fixes that can short-circuit the negative feedback loop between sovereigns and the financial sector.

These include a way to increase the firepower of the EU's bailout fund which won't sacrifice the triple-A ratings of the few euro zone sovereigns that still have them, recapitalisation of the region's banks, and a private sector involvement in Greek debt restructuring that won't compound banks'

Domestic politics is hampering efforts to produce such solutions but policymakers have made it clear they are aware of the consequences of failure.

Investors will therefore be on the lookout for any signs of co-ordinated efforts to shield the banking system from further fallout either before or at the G20 meeting of finance ministers in the coming week.


Banks will stay in the forefront of investors' minds as the earnings season for U.S. and European banks kicks off in the coming week with JPMorgan.

Deutsche's decision to ditch its 2011 profit target -- and the share price reaction -- may be a foretaste of the pain to come.

Weakening economic activity and the sovereign debt crisis have been a difficult mix for the financial sector, and investors know U.S. banks' earnings could presage even worse numbers from European lenders, which may have to further write down their exposure to southern European sovereigns - possibly to the point of requiring recapitalisation.

Dexia, which needed a bailout from French and Belgium authorities, may be the tip of an iceberg if euro zone policymaking sputters.


The European Central Bank's three-month dollar tender, which will be held in the coming week, will highlight the extent to which financial institutions have found it hard to access dollar funds but it is still unclear whether it will defuse the tensions still evident in money markets.

The prospect of three such tenders has not stopped three-month cross-currency basis swaps from widening. In fact, hefty demand for the ECB dollar loans may trigger more widening in one- and five-year cross- currency basis swaps, which are not covered by the central bank tenders.

The coming weeks will also show the extent to which the ECB's latest emergency measures are effective. In short-term euro markets, overnight Eonia rates are expected to fall below 1 percent after the ECB reintroduced one-year euro-denominated tenders to provide cash to banks struggling to access term funding.

Traders are also pushing back bets of an ECB interest rate cut to December, with a 50-50 probability it may move as soon as November, after ECB
President Jean-Claude Trichet gave little indication that lower borrowing costs were imminent.


The risks for the euro are seen skewed to the downside but timing is everything. Some banks are predicting a retest of its 2011 lows below
$1.29 while USB reports asset managers are selling it for yen, keeping the cross close to 10-year lows.

Still, the possibility of solo Japanese intervention is expected to increase if the yen appreciates past 100 per euro or its record high against the dollar.

While dollar/yen implied vols are the cheapest in the G-10 space (unsurprising given the 76-78 range that has prevailed since early August), any nervousness about FX rhetoric in the run-up to the coming week's G20 meeting could see short-dated volatility pick up and will limit sharp yen gains.

Speculation the SNB could raise the floor it has set for the euro/Swiss franc rate will also stop the single currency ceding too much ground on this cross for now. - Reuters

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