IG Markets - Afternoon thoughts - Nov 10

Across Asia, regional markets are weaker as the headlines out of Europe overnight continue to affect sentiment. Asian markets picked up a negative lead after Italian debt yields escalated to euro-era record levels. The 10-year Italian bond yields topped 7% for the first time. In economic news, China’s trade surplus widened in October, but missed economists’ expectations. The Hang Seng is leading the decline in the region with a 4.4% drop. The Nikkei is down 2.4% and the Shanghai is 1.2% weaker.

Australia's S&P/ASX 200 is down 2.7% at 4230, after hitting a four-day low of 4205. This came amid heightened concerns about the eurozone, after Italian bond yields hit a euro-era high of 7.5% and peripheral eurozone spreads versus German spreads blew out on the prospect of Italian political hiatus and higher margins on Italian debt. Financial names are leading broad-based declines, with major banks down 2.6% to 5.8%, although ANZ and the National Bank are ex-dividend. Resources are also underperforming, with BHP Billiton down 2.4%, Iluka declining 6%, and Woodside Petroleum dropping 3.1%. In economic news, unemployment fell to 5.2% in October from 5.3% in September, and full-time jobs rose by 20,000. Both these figures beat expectations, but have not really done much for the Aussie market.

In company news, Myer is outperforming its peers after being upgraded to buy from neutral by UBS. The broker also gave it a $2.65 target from $2.35 previously following upbeat management commentary earlier this week.

After the run we had enjoyed in previous sessions, many would have been optimistic that we may finally see a solution to Europe’s debt crisis. However, last night’s sharp reversal would have definitely spooked some of the investors who were thinking of starting to dip their toes in the water yet again. There was no real conviction from the bulls in the gains we saw on Tuesday and Wednesday as evidenced by the relatively low volume. This would have made many traders doubt the rally was going to last long. The fact that Angela Merkel is now working on a plan to make it possible for European nations to exit the euro area shows a shift in dynamics for Europe. It seems EU leaders are fed up and want a plan in place to enable them to leave behind nations who are not committed to making the EU work. After the problems experienced with Greece, such a plan would make it easier for EU leaders to deal with a crisis in the future. In the near term though, this is likely to rock the boat further.

Following today’s strong employment figures and comments from RBA Assistant Governor Phil Lowe, some analysts are beginning to doubt the possibility of a rate cut next month. Mr Lowe indicated that the Central Bank may have already achieved its goal of restoring the setting of monetary policy to neutral with just one cut in interest rates. However, Goldman Sachs continues to forecast a December rate cut of 25 basis points and feels the data was not strong enough to change it, particularly with the uncertainty in Europe.

Turning to the forex market and it was a horror night for risk currencies, with the euro feeling the full brunt of a market that is searching for answers and finding none. As soon as LCH Clearnet announced it was raising the margin it applied to Italian debt, we knew it could be dark days in fixed income land, and when the debt markets opened and sellers came out to play, so did EUR/USD. LCH Clearnet decided to raise margins to try and smooth out volatility in seven to ten year maturities given the heightened political instability in Italy. However, the initial reaction was one of panic, with Italian ten-year bond yields pushing up to 7.48%. Traders clearly took the margin increases as a sign that Italy’s asset quality is diminishing and saw clear comparisons to Portugal and Ireland in the lead up to their bailouts. An article in Germany’s Handelsbatt commenting on Angela Merkel’s CDU party making it possible for EU members to exit the EMU, while effectively retaining membership in the EU did the rounds, again highlighting that core Europe is warming and perhaps preparing for a ‘two-speed’ Europe. Italian yields did manage to find some buying support as the session went on, mainly thanks to aggressive buying from the ECB. The market wants to see the ECB become lender of last resort, however as we have heard time and time again, it simply does not want to go down this road. This would involve printing euros to buy Italian debt, however in the short term, this is not an option it has at its disposal, and is not even legal at present, though this is what the market seems to be demanding. Tonight we will see Italy planning to sell up five billion euros in 12-month bills (around 20:30); this will be closely monitored to see the bid to cover levels ahead of Monday’s auction of five-year debt. Given the current spike to yields, one would think demand will be lacklustre and could be another major headwind for EUR/USD Given all the negative news flow out of Europe, one suspects the path of least resistance is clearly down with a move to 1.35 in its sights.

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