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Financial Markets: Headlines for October 24

October 24, 2011

EQ The Nikkei rose through the first half of the session and US equity market futures were stronger (DJIA Dec’11 +51); European officials indicated greater agreement on measures to stem the crisis although no concrete decisions were taken leaving focus on Wednesday’s summit; US and European equity indices rose strongly at the end of the week as some US companies posted better-than-expected earnings, crisis meetings got underway in Europe and France seemed to soften its stance that the EFSF should be able to borrow from the ECB; the S&P 500 closed at the highest level since 3Aug, up 1.9% to 1238.25 on Friday and +1.1% on the week; Stoxx 600 shot up 2.5% on Friday (financials +3.4%) and posted a 4th consecutive weekly gain (+0.2%)

FX The euro briefly touched 1.39 versus the dollar on Friday, ending up 0.6% at 1.386, and maintained similar levels during today’s Asian session; USD/JPY dropped to a post WWII low of 75.78 on Friday and has regained little ground, trading around 76.2

FI USTs closed slightly lower and the curve steepened further; the 10yr yield rose 3bps to 2.219% but was still down 3bps on the week; the 2/30s steepened to a 1-month high of 299.6 from 296.5bps a week ago; Bunds were under sharp pressure during the risk rally and the 10yr yield rose 11bps to 2.102%; Italian and Spanish bonds rebounded from early lows and outperformed ahead of the weekend crisis meetings, although the ECB was reported in the market as well; the Italian 10yr yield declined 12bps to 5.869% and the Spanish -6bps to 5.435%

€ EU finance ministers have reportedly decided that banks should be subject to a 9% core tier 1 capital ratio and would have until 30 June 2012 to reach the target; this would put the capital shortfall at €100-110bn of which 38% relates to “programme countries,” which might imply that actual new recapitalization would be smaller than €100-110bn; banks could be subject to constraints on bonuses and dividends until the 9% target is hit – Reuters

€ EU leaders are considering several types of guarantee schemes to backstop banks, including reintroduction of national backstops, EU aggregation of national guarantees coordinated by the European Banking Authority; or structured aggregation of national guarantees in a special vehicle set up by the European Investment Bank – Reuters

€ German Chancellor Merkel said that decisions will not be made until Wednesday and that these will not be the last steps since more will be needed on growth and fiscal discipline; finance ministers have largely agreed to recapitalize banks; she said there are two models for boosting/leveraging the EFSF, neither of which involve the ECB

€ EC President Van Rompuy said there is now “a spirit of compromise” between France and Germany and leaders have narrowed down options on the EFSF to two models, and could merge them; leaders are “exploring the possibility of limited treaty changes” which would have to be agreed by all 27 EU nations; leaders are asking for reassurances from Italy about implementation of structural reform and austerity measures

€ EU President Barroso: "The G20 should ensure that the IMF has adequate resources to fulfill its systemic responsibilities and should explore possible contributions to the IMF from countries with a large external surplus”

€ Eurogroup Chairman Juncker said that finance ministers agreed on Friday that "we have to have a significant increase in the banks’ contribution" to the Greek aid programme

€ Euro area finance ministers approved release of the next tranche of Greek aid in the context of the current adjustment programme, pending IMF approval; disbursement expected in the first half of November; they “will conclude a second economic adjustment programme for Greece, with an appropriate combination of additional new official financing and private sector involvement" – Reuters

€ Troika report on Greece: Greece’s debt/GDP ratio could be brought to 120% by 2020 if there was a haircut of 50% on bonds held by the private sector; the haircut would have to be at least 60% to bring debt/GDP below 120% by 2020

€ S&P said that a double-dip recession in Europe would likely lead it to downgrade by "one or two notches" the ratings of France, Spain, Italy, Ireland and Portugal

$ Fed’s Yellen (voter) said the Fed is prepared to employ its tools as necessary; there are significant downside risks to the recovery, largely stemming from Europe and potential effects on banks which could tighten the supply of credit; bond purchases across maturities might become more appropriate if conditions call for greater accommodation; Fed continues to explore its means of communication

$ Feds’ Tarullo (voter) sounded a call for more easing: "there is need, and ample room, for additional measures to increase aggregate demand in the near to medium term, particularly in light of the limited upside risks to inflation over the medium term”; “large-scale purchase of additional mortgage-backed securities" should move back to the top of the Fed’s list of options

$ Fed’s Kocherlakota (voter; dissenter) is in favor of augmenting the Fed’s communication strategy and said they should use explicit metrics like unemployment and inflation data to explain policy; more monetary easing can help the labor market but it adds to inflation risk; he said the Fed appears to be more tolerant of inflation risks than it was in 2010; in his view the recent increases in core inflation are largely driven by domestic forces, not by global commodity prices

$ Fed’s Fisher (voter; dissenter): temporary drags on growth in H1 seem to be digested or reversed; he will urge a reversal of accommodative policies if inflation and expectations start to rise; he remains skeptical of Operation Twist and more easing: "You would be hard-pressed to now say that still more liquidity, or more fuel, is called for given the $1.5trn in excess bank reserves and the substantial liquid holdings businesses are hoarding"; he is not inclined to commit to more Fed action to support the housing market

€ The German IFO business climate index fell further to 106.4 in October from 107.4 in September and matched a level last seen in Jun’10, but the result was marginally above the consensus forecast of 106.2; the expectations measure fell as expected to 97.0, the lowest since Jul’09, down from a revised 97.9 (originally 98.0); the current situation measure declined 1.2pts to 116.7; in the business sector breakdown, the climate was judged to be worse across manufacturing, retail, wholesale and construction; the services climate rose to 17.4 from September’s 15-month low of 16.5

€ French INSEE business confidence remained on a steep downward trajectory and fell to 97 in October from 99 in September, disappointing versus the consensus forecast of 98; the index has dropped 12pts over the last four months, the steepest fall since Mar’09

£ UK public sector net borrowing excluding financial sector interventions was £14.1bn in September, below consensus of £15.0bn, and August borrowing was revised down to £13.7bn (originally £15.9bn); in the fiscal YTD, borrowing was £63.5bn versus £71.0bn in the same period of a year ago


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