Global Markets Weekly - 18 January 2010

• Investors took last week’s “known unknowns” in their stride…
  Many of the risks that look likely to dominate in 2010 were in evidence last week, and the markets mostly took these in their stride. Despite monetary tightening in China, fresh doubts about Greece’s creditworthiness, weakness in US retail sales and consumer confidence and a new levy on the US banking system, the S&P 500 hit a new 10-month high during the week. Apart from China, most emerging markets also continued to generate decent returns. Oil hovered around $80/bbl, and gold recovered from its recent correction. In the currency markets, sterling made modest gains against the euro and dollar.
• …and it may take an “unknown unknown” to shake their composure.
  The VIX Index of implied volatility in the S&P 500, also known as the “fear” index, remained at its lowest levels for 16 months, supporting the view that investors are already well aware of the risks facing the global markets and economy. To borrow an analogy from Donald Rumsfeld, there are ‘known knowns’ and ‘known unknowns’. It could take an ‘unknown unknown’ occurring to seriously rattle investor confidence, rather than the odds of a known risk rising a little.
• The UK appears to be out of recession, but limited credit growth is likely to slow the recovery.
  The UK’s National Institute for Economic and Social Research (NIESR) estimated 0.3% growth in the UK economy over the final quarter of 2009. The official estimate will be released by the Office for National Statistics on 26 January. If the NIESR is correct, the UK will have officially ended its worst recession since the Second World War. However, it could be a very gradual recovery, given the depth of the contraction and the time it will take for the financial sector to heal before it can support lending growth.
• US banks also face a new levy that may suppress lending appetite.
  Indeed, continued pressures on the credit system were in evidence in the US, where President Obama announced a levy on the 50 largest US banks and financial institutions, based on the size of their assets excluding already-insured retail deposits and shareholder equity. The measure will increase competition between banks for retail deposits, add to pressure to reduce balance sheets and potentially suppress appetite to lend. It may also increase M&A activity in the sector.
• China has the opposite problem – lending is too strong.
  China has the opposite problem - too much credit - with money supply growing at an annual rate of 30%, stoking increases in asset and consumer prices. Investors have largely reacted with composure to a token 4 basis-point (bp) increase in the 3-month bill rate earlier this year and to Tuesday’s move to increase bank reserve requirements by 50 bp to 15%. Revaluing the renminbi is an option. While in the short term it would hit the equity market, which is dominated by exporters, domestic-oriented companies would gradually benefit from consumer’s greater spending power.
• Greece’s large, opaque budget deficit has once again spooked investors.
  Finally, Greece revealed that its restated 2009 budget deficit, at 12.7% of GDP, may still be too low. The lack of clarity triggered a spike higher in Greek bond yields and CDS spreads. With 200 years of history showing that sovereign debt crises tend to follow banking crises, it looks as if history may be about to repeat itself.

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