Moods improved…

Last week on Monday we wrote:

European politicians will be back facing the wall this week as three troubled sovereign will try to sell bonds: Belgium today, Italy tomorrow and Spain on Thursday. After a failed auction in Germany last week, markets may be really nervous about those three tenders. We got used to that “two steps back, one step forward” approach that has been applied for nearly two years and since we are just two steps back and politicians face the wall and we have the Ecofin meeting there might be time for a step forward.

Indeed a step forward has been made and primarily not by politicians but by central banks, most notably the Fed that decided to support non-US banks. This was an ideal quencher and in conjunction with better-than-expected US data (yes the US economy surprised once again, suggesting it may be ready to grow faster again, even though Europe and high oil prices continue to pose a downside risks) helped to lift market sentiment substantially.

…but markets diverged

While moods improved in general, this improvement was strikingly uneven. US equities skyrocketed which was partly an answer to US macroeconomic reports. However, European equities surged as well even as the PMI confirmed an ongoing slowdown. Meanwhile the EURUSD inched up only slightly, despite a noticeable improvement on bond markets in Europe (10Y yields on French and Austrian debt went down by some 60 bps and on Spanish and Belgian debt by whooping 110-120 bps).

This is a double-edged sword. Should Europe agree on German proposal and Germany offer some “sweeteners” markets may continue to recover and the EURUSD may well catch up to other markets. Even if the ECB cuts rates the sentiment should overweight this negative news. However should politicians fail (haven’t we seen that before?) this gap might be closed with equity prices going down (and yields in ex-Germany Europe going up).

Europeans hold a key - again

This week, with an absence of the key US data, the full attention will be (surprise!) back on Europe. Even though the EU summit begins only on Thursday evening, there will be a long stretch of meeting in different configurations between Merkel, Sarkozy, Monti, Draghi and even Geithner. The first meeting between Merkel and Sarkozy begins today in Paris.

Przemysław Kwiecień PhD, Chief Economist

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