Eurozone periphery debt doubts reassert grip

Eurozone debt concerns reasserted a hold over the markets this week as the recent sell-off in US Treasury bonds was halted and worries about Chinese policy tightening faded.

Further evidence of accelerating economic growth in the US and Germany bolstered optimism over the global recovery, although the Federal Reserve maintained its extraordinary level of support for the markets at its scheduled policy meeting.

But it was renewed uncertainty about the outlook for the eurozone periphery that provided the key price driver as investors focused on rating agency actions and a summit of EU leaders in Brussels.

Moody’s Investors Service warned of a potential downgrade to Spain’s sovereign rating – and a subsequent auction of Spanish 10- and 15-year debt saw yields rise sharply.

Moody’s then followed up by cutting sharply Ireland’s credit rating – by five notches – while the International Monetary Fund warned of significant risks to Ireland’s ability to repay an aid loan from the organisation, part of an €85bn bail-out package for Dublin.

The Spanish 10-year government bond yield hit its highest since September 2000, and Irish yields also rose sharply.

The markets took little reassurance from an agreement by EU leaders to establish a permanent crisis management mechanism from mid-2013.

Carsten Brzeski, economist at ING, said while the new mechanism should safeguard the eurozone’s stability in the future, it did not solve the current crisis.

“European leaders failed to address the issue of debt sustainability and possible insolvency problems prior to 2013,” he said. “Debt restructuring, a common eurozone bond or an increase of the current, temporary European Fin-ancing Stability Facility? None of these issues have been addressed.”

The heightened doubts over the eurozone periphery put the euro under some pressure. The single currency fell 0.6 per cent against the dollar during the week and hit a record low against the Swiss franc.

The dollar, meanwhile, found support from further indications that the US recovery remained on track.

Notable among a string of data releases, US retail sales last month reached their highest level for three years, while the Philadelphia Fed’s index of manufacturing activity in the mid-Atlantic region – one of the first December surveys to come out – hit its highest since April 2005. Housing and labour market figures were also broadly encouraging.

“The recent run of stronger economic data has prompted us to raise our fourth-quarter GDP growth forecast to 4 per cent annualised, from 2.5 per cent,” said Paul Ashworth at Capital Economics. “Based on the higher starting point for GDP going into next year and the new fiscal stimulus – which is worth an additional $300bn above what we previously had factored in, we now expect growth to average 3 per cent in 2011.”

The mounting optimism over US growth, as well
as uncertainty over the
outlook for inflation, continued to unsettle US government bonds.

Over the week, the yield on the 10-year Treasury was unchanged, at 3.34 per cent, off from the peak of 3.56 per cent hit earlier in the week. Thirty-year bond yields were also unchanged at 4.42 per cent.

Traders were unmoved after the Federal Reserve made only a modest improvement to its economic outlook following a meeting of its Open Market Committee and maintained both its asset purchase plan and reinvestment policy.

Meanwhile, the German economy showed few signs of running out of steam, with the latest Ifo survey showing business sentiment at its strongest level since 1991. The yield on the 10-year Bund ended the
week flat at 3.03 per cent.

The Bank of Japan’s Tankan business survey declined for the first time since the first quarter of 2009, but by less than had been expected. A string of UK data also pointed to relatively robust growth – although stubbornly high inflation figures prompted some analysts to question the outlook for sterling.

China’s inflation outlook also came under scrutiny after data last weekend showed consumer prices rising 5.1 per cent year-on-year in November, up from 4.4 per cent in the previous month. But investors managed to put worries about a rise in Chinese interest rates to one side.

This easing of China concerns, plus the broadly positive global growth outlook, helped leading equity markets extend their December rally. The S&P 500 was up 0.1 per cent, for a weekly rise of 0.3 per cent, while the FTSE Eurofirst 300 was a fraction higher, with both indices hovering near 2½-year highs. The Nikkei 225 rose 0.9 per cent, hitting a seven-month peak.

In commodities, gold edged back in response to the firmer dollar while oil also ended the week just slightly higher.