Last week we noted that the foundations for a healthy 2012 are not yet in place, and that the jury is still out on the implications for sovereign bonds of the ECB's decision to once again offer unlimited liquidity. Thus far, we don't have conclusive progress on either point, but the trend is stable at the moment.
This week, Spain had a successful bond auction, and the first unlimited refinancing operation today has been met with high demand. The early indications are that the ECB has succeeded in restoring confidence, and that the banks will play along, using liquidity to reduce risk premiums. Whilst we welcome the risk-on nature of markets, particularly at these technically important levels, we would caution on excessive optimism. With Eurozone sovereigns needing to issue an almost €1.5 tln of debt next year, the jury will remain out for some time.
Unlimited liquidity may be enough to help reverse the credit freeze, a big plus to be sure, and possibly enough to help governments get their debt issuances done. But, unless there is a structural change in the European economy, it is unlikely to be enough to bring yields to sustainable levels, meaning that the debt crisis may continue to worsen, even if it does so away from the media spotlight. The current market dynamic is driven by monetary factors, but unfortunately political news is not presently moving forward as clearly as it was earlier in the year.
China is growing well, but more cautiously than in recent years. The US is currently performing well, in line with our predictions and better than many had expected. But unlike in the early noughties, it is not growing enough to pull the rest of the world up with it. Europe cannot expect another global macro free lunch, and needs to act decisively. Absent such assertive action, it is unlikely to experience an economic upswing sufficient to reverse the enormous economic damage caused by its reluctance to implement crisis response agreements.
For now, the market has a bit of a festive mood, and we welcome this. Technically and tactically, this rally might carry us through for several weeks, but it could turn at any time, and if the party goes on into January without reforms, it will quickly start smelling of excess.
Since the markets wait for no man (well, except perhaps a central bank head or two), we are working through the festive season. And so we will have a chance next week to wish you Happy New Year. But, Christmas itself is upon us. Enjoy it to the fullest.
Best regards,
James
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