Bond Yields in Safe-Haven Markets Decline

EU debt crisis remains in focus given the very wide 10Y spread between Italy and Germany as well as a larger Spanish deficit in 2011 than previously thought. Merkel and Sarkozy are scheduled to meet on 9 January.

Modest decline in US equities on Friday, while US Treasuries continue to gain from EU debt crisis.

Mixed session in the Asian equity markets this morning. Chinese PMI surprises on the upside. No major events today, but we have a full schedule this week with plenty of important US economic data.

Markets Overnight

As we enter 2012 focus is still on the EU debt crisis after the new Spanish government on Friday announced that the deficit in 2011 was likely to be 8% rather than the projected 6% from the previous government. The New Year’s speeches from the various EU leaders again signalled the significant will to keep the euro together, and the new Spanish government has announced new measures to cut spending and increase revenue. However, the key will be Italy given the solid redemptions the country faces in the next three months. It has to repay EUR53bn in Q1, and with 10y yields at 7% it makes refinancing very expensive.

On the back of the ongoing problems in Euroland, the US equity market ended 2011 with a modest decline on Friday despite fairly decent economic data from the US. However, US Treasury bonds continued their rally, as investors are avoiding EU sovereign bonds given the uncertain outlook for Euroland and the ongoing EU debt crisis. Demand for Treasuries is still high despite the ongoing debate on the Debt Ceiling and gloomy fiscal outlook.

It has been a mixed session in Asian equity markets, where some indices are up this morning, while others have followed the negative sentiment from US equity markets. Nikkei is up with 0.7%. Late last night the Chinese PMI for December was released and surprised on the upside, rising to 50.3 in December (consensus 49.1) from 49.0 in November. This should ease some of fears of a hard landing in China.

In the currency markets the euro has moved below the 1.30-level versus the dollar and 100-level versus JPY. Hence, pressure remains. Both SEK and NOK are holding up very well. EUR/SEK has moved below the 9.00-level and is trading at the 8.91-level. EUR/NOK is trading at 7.74-level and is fairly stable.

Global Daily

Focus today: US markets are closed today. Apart from the final PMI manufacturing data out of the eurozone there are no major scheduled events in Europe, so it looks to be a quiet first day of the year. Later this week important economic data are awaiting, with ISM and FOMC minutes tomorrow and non-farm payrolls on Friday. Elsewhere, the European debt crisis is expected to continue to dominate the markets.

Fixed income markets: During the past week bond yields in safe-haven markets have declined notably on demand for secure assets before year-end. This includes US bond yields, which have declined some 15bp, thereby defying the ongoing flow of strong US data. Generally, investors remain cautious. Focus is still on the European debt crisis and in particular on the upcoming refunding auctions in Italy and Spain during Q1.

Importantly, Euribor fixings are now coming down at a rapid pace in a sign that the ECB liquidity measures are working. This is a positive signal regarding systemic risk and will contribute to the downward pressure on short European swap rates throughout this quarter. Apart from this, our core views for Q1 are spread tightening in short end of EU government bonds to swaps, lower Eur vol, US-Eur spread widening and curve steepeners in the US. With US markets closed volumes will be thin today and the markets are likely
to stay cautious before the important economic events later this week.

FX markets: There are no major market movers to drive the FX market today. However, the market might continue to shun the euro as has been the case during the Christmas week. The market might very well be concerned that the EUR157bn in eurozone debt that will mature in Q1 will be euro negative. EUR/USD has now effectively fallen below the psychological important 1.30 level with the latest blow to the euro on 30 December when the Spanish government said that the deficit in 2011 would reach 8% instead of the expected 6%. In 2011 the euro for the first time had two consecutive losses against the US dollar and it fell to a record low against the yen with EUR/JPY falling below 100 for the first time just before New Year. We continue to look for a stabilisation of EUR/USD at 1.28 on a three-month horizon.

Scandi Daily
PMI data from both Norway and Sweden. Not expected to have any impact on the market. We believe we will see a stabilisation or even a slight rise in Norwegian PMI in December after the significant drop in the autumn and after it fell below 50 for the first time since March 2010 in November.