E.U. Bailout To the Rescue Sends Stock Markets Soaring

By: PaddyPowerTrader

Well the cavalry finally arrived and better late than ever. In as dramatic a U-turn as we’ve witnessed in financial markets history the EU goes nuclear with a 3D type of unprecedented measures to remove the threat of global contagion. This is the mother of all aid plans that dwarfs previous leaks and speculation in a show of steadfast political determination to stop the rot.

This has serious implications for ECB independence and leaves Monsieur Trichet with a large amount of egg on his face after his bizarre performance at last Thursday’s ECB news conference.

Today on just another manic Monday in response the financial markets are buoyant (a case of flying PIIGS you might say) in the aftermath of the measures announced by the EU over the weekend. European stocks have rallied strongly led by the Spanish IBEX which is up 12% and banking stocks from Friday’s close. Meanwhile, Greek 10yr yields over Germany have narrowed by over 600bps whilst 5yr Greek CDS have tightened 337bps. High beta currencies have surged, particularly the European peripherals versus JPY (NOK+4.6%; SEK+4.9%) and EM FX. Front-end FX volatility is down sharply, particularly for the Yen crosses. For now, the short squeeze should continue to support EUR sentiment as the EU/ECB/IMF has provided a backstop for Greece and other peripheral Euro area countries. Whether the proposed measures receive parliamentary ratification remains to be seen. Further out, the announced measures, whilst not Quantitative Easing in its purest sense, (as seen in the UK and the US) will drive to an expansion in ECB liquidity.

Today’s Market Moving Stories

QE comes to Europe
After taking a beating in the markets last week, Europe responded in a big way.
EMU politicians and the ECB have seriously upped the ante in terms of their willingness to defend the currency union. The departure of Greece and other countries now looks a more remote possibility and a move towards fiscal union becomes more likely. They’ve produced a €750bn safety net to combat the widespread contagion. The major elements include a €60bn stabilisation fund from the European Commission, €440bn in loan guarantees from Euro member states and a €220-250 top-up from the IMF. This comes on top of the €110bn bailout for Greece.

The ECB decided in a massive amd embarrassing U turn (clearly under immense political pressure) to buy public and private securities on the secondary market, bringing quantitative easing to Europe. Indeed they have already been seen via the Bundesbank & the Banque De France this morning openly buying peripheral PIIGS paper & bonds.

The ECB also announced a 6-month refi operation with full allotment on 12 May, a return to fixed-rate full allocation 3-month LTROs on 26 May and 30 June, and a re-opening of USD swaplines.

The IMF Executive Board formally approved the IMF’s €30bn part of the 3-year Greek programme on Sunday, voting to disburse €5.5bn immediately. Further, Germany’s Constitutional Court rejected a legal challenge against aid to Greece.

Increased austerity measures in the peripheral countries will hurt growth by more than previously expected. As a result, we revise down our growth forecast for the Euro area from 1.7% to 1.4%, and push back the first ECB rate hike until late 2011.

The Eurozone’s response creates political risk. Note Merkel’s CDU party suffered a significant defeat in the North Rhine-Westphalia elections that has resulted in the loss of her coalition’s majority in parliament’s upper house. This will make it all the harder to get through desired economic reforms and, more pertinently, demonstrates unhappiness amongst German electors at the financial costs of sustaining the euro. If political will to support EMU fades then risks of it unwinding will grow again.

Greece
A Kathimerini newspaper poll showed 68% of respondents support more strikes and protests, although a smaller 39% plan to actively participate. 36% trust PM Papandreou’s leadership, down from 47% in April.

Portugal
PM Socrates promised other EU leaders that Portugal will cut its 2010 deficit to 7.3% of GDP, more than the 8.3% previously planned level, according to a Reuters source. Separately, parliament passed two tax bills on Friday, including a new 45% tax on incomes over €150k and a 20% capital gains tax. Further, Portugal’s debt agency will buy back early on Wednesday the remaining €4.6bn worth of bonds maturing 20 May. This is the only Treasury bond maturing this year. Trade deficit was €1.6bn. in March after a revised 1.5bn in February.

Spain
Spain is set to announce an extra 0.5ppt of GDP cut in its budget deficit for 2010 and an extra 1ppt in 2011, according to EFE news agency. These cuts would affect the official deficit targets of 9.8% of GDP in 2010 and 7.5% in 2011. House transactions were up 9.0% yoy in March, down from the 18.7% rise in February.

FX: Post the Euro bounce [and remember that the market is short the euro], I expect renewed downward pressure on the euro. The ECB’s reputation independence and monetary discipline is tarnished by the move to buy bonds. While this can be overstated (the Fed, BOE and BOJ have all undertaken extensive quantitative-easing), loose monetary policy, weak growth and greater political risk suggest that downside risk to the euro remains.

Equities: The bailout is without doubt good for equities. The financial sector now appears less vulnerable and I think that the reduction in the European sovereign bond risk premium will be sustained. The latter helps underpin attractive equity valuations. More broadly, a combination of loose monetary policy, steep yield curves and a weak euro should all help sustain earnings momentum even allowing for a growth drag from southern Europe. European non-financial large-caps in particular are strongly cash-generative and offer exposure to global economic recovery

Next key dates

•May 11: First USD liquidity providing operation by ECB
•May 12: Spain’s PM Zapatero presents new set of tightening measures to Spanish parliament
•May 12: EU Task Force set up to examine tightening of fiscal rules presents its proposals
•May 12: ECB to conduct 6m refi operation at full allotment with indexed rate
•May 17/18: Eurogroup/ECOFIN meetings – Spain and Portugal commit to new measures

Company / Equity News
As part of its plan to focus on core commodity businesses announced back in October, Anglo has agreed to sell its Zinc portfolio to Vedanta Resources for USD1,388m. Anglo American Zinc comprises the Skorpion mine in Namibia, the Lisheen mine in Ireland and a 74% interest in Black Mountain Mining in South Africa, with the sale of each specific asset expected to complete separately.

Centrica has put out an interim management statement highlighting a strong start to the year for its downstream and residential UK business thanks to higher demand (residential gas demand up 7%, electricity up 2% due to cold weather) and new customer numbers, with higher upstream production post Venture being offset by low prices. Net debt is expected to be GBP3.3bn at the end of Q1 (after cash margin out of GBP700m) compared with GBP3.1bn at the end of December. According to Centrica “the outlook for Group earnings for the full year remains positive,” subject to the usual commodity price and weather caveats.

BAA has reported a 21.6% drop in traffic for the London airports in the month of April effectively due to the Volcanic ash cloud which closed the airports for five and a half days, and caused subsequent traffic disruption. Heathrow traffic was down 20.8%, with the disruption causing a 21% drop in traffic, and Stansted was down 24.4%, with the ash cloud causing a 21% fall. BAA recently quantified the financial impact at GBP28m in their Q1 results, which is not material, and the YTD traffic figure is down 5.9% for the London airports.

Disclosures = None

By The Mole
PaddyPowerTrader.com

The Mole is a man in the know. I don’t trade for a living, but instead work for a well-known Irish institution, heading a desk that regularly trades over €100 million a day. I aim to provide top quality, up-to-date and relevant market news and data, so that traders can make more informed decisions”.© 2010 Copyright PaddyPowerTrader - All Rights Reserved

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