Global Markets Weekly 

6 December 2010

• Markets rally on short-term euro-zone reassurance from the ECB, allowing investors to focus on generally good economic data
  
  Risk assets rallied in general as the European Central Bank mollified euro-zone concerns, allowing investors to focus on encouraging economic data. Equity markets enjoyed broad gains, led by rebounds in Ireland and Greece, although a disappointing addition of 39,000 US payrolls for November caused some pullback late Friday. Commodities benefited most from good economic news and speculation that the ECB had moved closer to quantitative easing (QE), despite strong denials, with oil hitting a two-year high. Sovereign bond yields edged up in response to better news on growth, which supports our positive stance on risk assets. But sensitivity to policy decisions also highlights our view that economic problems and political risks will continue to constrain returns and increase volatility, especially in developed markets.
  
• This week’s euro crisis dissipated by ECB action – but structural risks and likelihood of further problems remains high
  
  With the Irish bail-out package failing to address solvency issues, peripheral euro-zone bond markets weakened further. The definition of ‘peripheral’ is also getting muddied, with yields on Belgian 10-year bonds having risen by 60 basis points in the last month. With politicians having failed to convince investors, focus shifted to the ECB. We were disappointed that the ECB stopped short of QE, though increased ‘sterilised’ purchases of periphery bonds fuelled a sharp rally. However, economic history teaches that no single currency across sovereign nations has survived without the combination of both monetary and fiscal union and the EU will likely wrestle with this reality in 2011 in order to save the euro in its current form. Default or devaluation is the usual route for any country facing the kind of sovereign crisis that has already engulfed Greece and Ireland. Capital markets will press until a credible political solution is found, which will involve much greater centralisation of fiscal policy.
  
• German consumer spends more freely as economy continues to boom
  
  The euro-zone services sector Purchasing Managers Index (PMI) rose to 55.4 in November, led by the continued German advance and supported by France. Others saw stagnation, such as Ireland, or continued decline, such as Spain. However, news of the largest monthly increase in German retail sales for three years encouraged hopes that the export-led recovery was broadening, which would support growth elsewhere in the euro-zone. We continue to favour exposure to Germany within this region’s equity markets.
  
• Headlines point to ongoing US recovery, but deleveraging remains a drag
  
  The US ISM manufacturing index moderated slightly to 56.6 in November, but remained well above the 50 level that indicates growth. More significantly, growth appears to be feeding into higher employment, with new unemployment claims trending down over the past month, although payrolls increased by less than forecast. Retail sales over the key Thanksgiving weekend were also positive, but the continued fall in house prices over the past month was a timely reminder that US structural risks will persist for years to come. Similarly in the UK, our cautious optimism was reinforced by the highest manufacturing PMI since 1994, helped by sterling weakness, but house prices continued to fall in November.
  
• Strong Asian economies prompt further policy tightening
  
  Strong PMI figures from China and India underlined the positive momentum in both these economies. But the interest rate hike by 0.25% in Thailand was a reminder that fast-growing Asian economies need to tighten monetary policy in the face of increasing domestic and external inflation pressures, if they are to sustain growth.

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