Strong Rebound in Risk Assets

Strong rebound in risk assets – US stocks closed 3% higher

European bond spreads narrowed further following a strong Spanish bill auction

Brent oil trades above USD107 and EUR/USD above 1.31

BoJ unchanged – says economic pick-up has paused

Focus today is on the ECB 3Y LTRO and BoE minutes

Markets Overnight

Strong rebound in risk assets. US stock markets gained about 3% yesterday – supported by a stronger-than-expected German IFO survey – and the positive sentiment has carried over to Asian trading. However, while Taiwan and South Korea are more than 3% higher, Asian markets have not been able to deliver as strong gains as seen in US trading.

Risk sentiment was also supported by strong performance on the European bond market following a  strong Spanish bill auction – with 10-year spreads against Germany narrowing further: Italy (-30bp), Spain (-18bp), Belgium (-15bp) and France (-7bp).

Part of the improvement in risk assets may  also  be related to  expectations of a fairly large take-up at the first 3-year ECB longer-term refinancing operation (LTRO) – with most analysts arguing that a big allotment should now be seen as positive, as it would support the financial system. The ECB has tried verbally to remove the previous „stigmatization‟ associated with its liquidity facilities. Allotment at the 3-year LTRO is announced at 11:15 CET.

EUR/USD has rebounded back above 1.31 and given that short positions in the market remain stretched  the current correction does have potential to see EUR/USD move temporarily above 1.32. However, until the market has fully priced the new de facto zero rate ECB regime, and until a trough in the global slowdown is confirmed, we expect pressure to remain on the euro. As a result, we have opted to lower our 3M forecast from 1.30 to 1.28, while keeping our 2012 year-end target at 1.38.

The Swedish krona has given back part of its post-Riksbank gain, but EUR/SEK still trades lower than before the monetary policy announcement and below 9.00. The Riksbank as forecasted cut by 25bp, but lowered its repo path by less than expected  - indicating just 30% probability of another 25bp cut. We expect the economic slowdown to be deeper than Riksbank forecast, however, and still see potential for significant rate cuts during 2012  – taking the policy rate down to 0.5%.


Global Daily

Focus today: The first of the two 36-month longer-term refinancing operations (LTRO), with the option of early repayment after one year, will have allotment today. Note that there will also be allotment on a 3-month tender. These very long LTROs could potentially improve the liquidity situation for the banking sector and thus alleviate refinancing risks and thereby the speed of balance sheet deleveraging. The introduction of LTROs could also have an impact on yields in sovereign debt markets (and already has), in particular in the short end as the proceeds from refi-operations can be invested in for instance Italian and Spanish bonds. BoE minutes will also attract some attention today.

Fixed income markets: Generally, sentiment has improved over the past two days and the downward pressure on yields has been  reduced by better-than-expected US and German macro data and a successful Spanish t-bill auction yesterday. There is little overall direction in the US and German bond markets, as we are still awaiting the S&P rating decision and lots of loose ends remain on the policy response  to the  euro crisis. Today the 3Y LTRO will be an important event for the markets. A large take would in our view be positive for risk appetite, i.e. bearish for safe-haven bonds and bullish for the European periphery. It would imply that the ECB, by introducing this instrument and easing collateral rules, supplied something that banks demanded. In the money markets a large allotment implies very large excess liquidity for long  – supporting lower EONIA and Euribor fixings eventually. On the other hand, if less than EUR300bn is allotted at the LTRO it would indicate that the instrument was less of a „game changer‟ than some might think. However, keep in mind that another 3Y LTRO will be carried out on 29 February 2012. Some banks might not find it attractive to boost the balance sheets just ahead of term. Hence, until we know the combined allotment of the two 3Y LTROs we are cautious in judging the success. On another note, the US will be selling USD29bn 7-year
notes tonight.

FX markets: A high allotment at the 3Y ECB LTRO is likely to support the euro and could trigger a further rebound in EUR/USD  – potentially even  towards the 1.3289 technical resistance. However, given the underlying trend lower in relative rates and the underlying weak global macro environment, we would prefer to stay neutral for now and await a potential rebound to position for renewed downside over the coming months. 

Scandi Daily

Sweden:  After the Riksbank‟s relatively modest forecast revisions we expect more
marked ones from NIER in its December assessment of the Swedish economy. The repo rate forecast will be lower than the Riksbank's. Apparently NIER has a very different view on resource utilization. The forecast will be published at 09:15 CET. At 09:00 NIER will release a new set of confidence data for households and businesses. We expect the decline to continue. Already now confidence for both are below normal.