IG Markets - Afternoon thoughts 12/12/11

Across Asia, regional markets are stronger after European leaders came to an agreement on how to curb the debt crisis. Markets across the region opened higher this morning in response to the positive reaction seen in US and European markets on Friday night. Investors cheered moves by European leaders to enforce tighter budget rules for nations and add EUR200 billion to the euro war chest. Sentiment has also been lifted by strong consumer confidence data from the US which hit a six-month high. With the crisis seemingly averted for now, Asian markets are rallying. The Nikkei is the best performer in the region with a 1.4% gain while the Hang Seng is up 1.3% but the Shanghai is down 0.7%. The ASX 200 is 1% higher on the back of a solid performance by the resource stocks. US and European markets are set to extend their gains with the futures pointing towards advances for those markets at the open.

Australia's S&P/ASX 200 is up 1% at 4247, with the cyclical stocks leading broad-based gains after the S&P 500 rose 1.7% following the EU summit. Headlines out of Europe are likely to continue driving sentiment. Some of the initiatives from the EU summit have put to rest some major concerns about wholesale funding markets freezing. However, this doesn't necessarily mean that Europe won't continue to be a battle in the short-to-medium term. Origin is up 3% after its LNG JV's latest off-take deal with Sinopec. Wesfarmers is down 1.4% after CBA downgraded it to Hold and Wesfarmers flagged a $190 million write-down at its Coregas unit. BHP Billiton is up 2.5%, while major banks are being led by Commonwealth Bank which is 2% higher. Whitehaven Coal and Aston Resources are in focus after the two announced their merger. There are some concerns over recent economic data with this morning’s narrower-than-expected trade surplus numbers disappointing. Some economists feel that an erosion of the trade surplus will amount to a material negative income shock to the economy and will likely lead to more rate cuts.

All things considered, it was a good reaction to the European summit. Despite all the negative tape, the most important indicator of sentiment will be the bond market with EUR 12 billion in supply this week. Italy is due to auction EUR 7 billion worth of one-year bills tonight. Traders are likely to become more bullish if we see a sustained push above 200 day moving average on the S&P and the ASX 200 above 4300. We’ve seen the ASX 200 close above 4300 just seven times in over 90 trading sessions.

EUR/USD started the new week on a flat note, trading between 1.3386 and 1.3359 as participants pondered whether the EU summit had done enough. Judging by the pick up off the low on Friday, it seems the new fiscal compact that the 26 European governments agreed on might actually mark a step towards a fiscal union; however it is going to be a long haul getting there. The targets that have been announced are ambitious to say the least, and when push comes to shove and the extremely aggressive austerity starts to bite, how will governments react to potential uprising, given that at the end of the day they still need to win elections? We still feel the most positive situation was the measures put in place by the ECB on Thursday, whereby the ECB will lend for three years, taking in a broad range of collateral on lower margins. The outcome of this, as Morgan Stanley put it, is more than merely enhanced liquidity for the banks, it’s a form of ‘passive QE’. Still, despite the ‘risk on’ mentality on Friday, there are major risks just around the corner, which suggests that traders will continue to sell rallies. Firstly, this week we have a massive amount of debt being auctioned in Europe, so this will be the first real test of whether the fiscal pact has calmed fears. The UK Telegraph put out a story late Friday titled ‘European Banking System on the Edge of Collapse’, quoting a London-based executive at a global bank, suggesting a major bank could fail within weeks. An Australian Financial Review report over the weekend suggested that S&P will decide whether to downgrade Eurozone countries in the coming days after its internal review on the EU agreements. There are some bright spots, so it is not all doom and gloom, but the risks in the short term are real. The October 27 downtrend is in place, and until we see a few days with EUR/USD closing above this level, we feel the bias is for EUR/USD to head lower.

The UK voted against being included in Europe's treaty changes on the weekend, which was seen in some circles as the first shots fired in an attempt to depart the EU. Given the woes that are affecting the region at present, this may not necessarily be a bad thing, particularly in light of the weighting the finance sector carries in the UK economy. Traders will be watching to see how the FTSE behaves in the coming sessions, and if markets react favourably to this news, we could see the FTSE outperform its European counterparts.

ENDS

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