Further signs that Greece might be nearing a resolution with the European Union over a debt rescue deal offered a positive backdrop to risk assets on Tuesday, with stocks in the US and UK in positive territory for the year.
The Vix volatility index – closely watched as a guide to risk aversion – fell 0.7 per cent to 19.12, not far away from a 20-month low struck in January.
However, both sterling and the euro remained under some pressure following the weakness seen in both currencies on Monday.
“The decoupling between foreign exchange rates and the broader sentiment in risk markets highlights the structural long-term concerns surrounding sovereign risk, notwithstanding optimism about growth or policy rates,” said Lena Komileva, G7 market economist at Tullett Prebon.
On the currency markets, sterling failed to re-test Monday’s 10-month low of $1.4784 but still ended the day another 0.2 per cent weaker. But the UK’s five-year credit default swap narrowed 5 basis points to 82bp, while UK government bonds rallied. The yield on the 10-year Gilt fell 6bp to 4.02 per cent, with the spread over German Bunds narrowing to 90bp from 98bp.
Worries over peripheral eurozone nations also showed signs of receding as the cost of insuring against sovereign debt default fell sharply. Indeed, the iTraxx SovX index of western European sovereign CDS prices fell below the investment-grade iTraxx Europe index for the first time since mid-January. Greece’s five-year credit default swap narrowed 32bp to 308bp, according to Markit data, while Portugal’s tightened 25bp. The Greek 10-year government bond yield fell a further 10bp to 6.16 per cent, off an earlier low of 6.08 per cent.
But in spite of the apparently easing fears of contagion within the eurozone, the euro touched a fresh nine-month trough against the US currency, before paring its decline. Jessica Hoversen, foreign exchange analyst at MF Global, said that beyond the issue of sovereign risk, the economic backdrop as well as the outlook for interest rates was driving the euro’s weakness.
“It is unlikely that the European Central Bank will be able to hike interest rates before the Federal Reserve, giving the dollar the interest rate differential and keeping monetary policy loose in the eurozone for some time,” she said.
“Fiscal policy, on the other hand, is likely to tighten not because of economic improvements but due to austerity and the need to reduce public deficits.”
Central bank exit strategies were in focus elsewhere as the Bank of Canada and the Reserve Bank of Australia held policy meetings.
The BoC left interest rates unchanged at 0.25 per cent and reiterated a pledge to keep them on hold until June – but said inflation and growth had been stronger than expected, prompting some analysts to suggest rates could be on the way up later this year. The Canadian dollar hit a five-week high against its US counterpart.
The Australian dollar inched up 0.2 per cent after the RBA raised rates by 25 basis points to 4 per cent – its fourth increase in five meetings – and signalled further tightening in coming months.
Global equities enjoyed a positive day. The S&P 500 rose 0.2 per cent. The FTSE 100 in London jumped 1.5 per cent, giving it a gain over the course of 2010.
The pan-European FTSE Eurofirst 300 rose 0.8 per cent and the Nikkei 225 in Tokyo added 0.5 per cent. Emerging market stocks rose for a third day.
Despite the push into positive territory for the year, John Higgins at Capital Economics warned US stocks faced a tough time and suggested the S&P 500 could end 2010 lower than it is now. He said valuations were no longer compellingly attractive, the economic recovery was likely to run out of steam, and that stocks could be hit by a scaling back of unconventional policy support.
In commodities, oil made a fresh foray above $80 but fell back to end the day at $79.68, a gain of 1.25 per cent. Copper extended its rise amid worries over supplies from Chile. Gold touched its highest level since January in dollar terms and reached fresh record highs in euros and sterling.