Glass Half-Full Argument: Positive Risk Sentiment Continues

The recent broad theme of an improved risk appetite in financial markets continues and there are a number of reasons for the global economy to feel as if its glass is half full at the current juncture – all of which are in some ways interlinked and indeed cross fertilising.

Peripheral yields yield
Continued improvements in the outright yields (or implied cost of funding) for the peripheral Eurozone nations has been particularly evident over recent sessions, particularly for the market sensitive nations of Spain and Italy, and interest rate term structures have normalised (outside of Greece and Portugal) whereby short-dated funding costs are lower than their longer term equivalents. In fact Spanish 10-year yields fell to their lowest level since November 2010, to around 4.85 percent.

Draghi turns the tap again
Risk sentiment has also been bolstered by the increased belief that the take up at the second European Central Bank 3 year Long-term Refinanciaing Operation (LTRO) liquidity providing operation will be substantial. FT Deutschland suggested earlier in the week that the banks may borrow up to EUR 1 trillion (though an amount similar to the first auction at around half that amount would seem more likely). The unlimited liquidity auctions from the ECB have been widely heralded as having prevented a potentially disastrous credit crunch in financial markets and for having enabled the interbank market to continue to function. Increasing the flow of available funds in the system should at some point be very supportive to the economy – once the uncertainties of the Greece situation have passed.

Manufacturing momentum
The global PMI data yesterday also highlighted the current risk positive mood as the Eurozone surveys showed some improvement and China manufacturing remained in expansion (leading many commentators to accept that a hard economic landing in China is off the table or has at least been delayed for a while longer). While the notable outlier was Switzerland, whose index slipped sharply into contractionary territory for the month, the better than expected outcomes in Australia and the UK and a strong reading in the US were enough to inspire an improved level of confidence.

“There is a lot to like about the January data” US ISM Holcomb

Greece ‘ing palms
A further risk positive lies in the fact that the Greek PSI talks appear to be entering the final stages and whilst I reserve some judgement about the ‘labelling’ of an almost 70 percent haircut on the Greek debt swap as voluntary and not a default, an agreement will still remove an element of uncertainty for financial markets and in that respect can be seen as a positive. The fact that the ‘sweetener’ of improved terms in the event of Greek GDP growth outperformance has been leaked as a likely addition may also make the bitter pill a touch easier to swallow.

So what does this mean?
In reality I feel that this can mean different things for different markets. The combination of a slightly stronger backdrop with central banks in Europe and the US flooding the markets with ever larger amounts of liquidity should be supportive of equities and with a very large amount of investor money on the sidelines awaiting clarity on the Eurozone debt and regulatory issues, there may be a lot of money that will need to participate in the stock market rallies if we continue to push new ground.

In FX the currencies that would traditionally do the worst in a risk-on world (CHF and JPY) have remained stubbornly strong despite the rising threat of intervention from the relevant authorities. EUR for me remains the weak spot, however, as I have oft mooted, the most efficient way to trade a short EUR position in the current environment is not against the USD.  My preferred vehicle remains GBP.

After a much better than expected UK PMI survey yesterday and a breakdown of the data which showed gains coming from new orders, employment and output, there is a very good prospect that the UK misses the much vaunted technical recession after a difficult Q4, and as the biggest risks to the UK remain Eurozone related, any positives in Europe should be of considerable benefit to the UK as economic differentiation comes to the fore.