Risk Appetite Has Returned Back At The Global Level After Reccession

Risk Appetite Has Returned Back At The Global Level After Recession

Risk appetite returned to the world’s financial markets at the end of a volatile week as Europe’s leaders took significant steps towards dealing with the region’s sovereign debt crisis.

Agreement on a second bail-out for Greece, which will see private investors participating for the first time, was accompanied by a deal allowing much greater flexibility for the European Financial Stability Facility (EFSF), the region’s main rescue fund, aimed at alleviating the debt burdens of aid recipients and limiting contagion fears.

Global equities – led by the banking sector – “non-core” eurozone government bonds and the euro rallied strongly as analysts broadly welcomed the deal, in spite of some reservations.

German Bunds and US Treasuries fell but gold held within striking distance of a record high hit during the week as investors sought havens.

“Although there remain some important reasons for caution – most notably related to the size of the EFSF and extent of investor participation – the bigger message is the restatement of the solidarity within the eurozone and the commitment to ‘do what it takes’,” said Nick Kounis, head of macro research at ABN Amro.

Jim Reid, strategist at Deutsche Bank, was also cautiously optimistic.

“For the near-term, it’s a bigger package than most were expecting and as a minimum seems to have brought some unity back between [eurozone] governments and the European Central Bank,” he said.

But Mr Reid warned that its ultimate success would largely depend on the ability of peripheral countries to use the breathing space it allowed them to make large internal adjustments.

Furthermore, he said, much would depend on whether the eurozone economy could squeeze out enough growth to allow for hope that countries can grow out of their problems.

“If growth falters, and if indeed we have a recession in the region over the next year or two, this package is highly unlikely to be able to prevent the crisis spreading.”

As such, this week’s data releases from the eurozone – and elsewhere – were not particularly encouraging.

July’s preliminary purchasing managers’ reports for the eurozone fell short of expectations – with the manufacturing index coming in barely above the level that indicates expansion. Surveys on German business confidence and investor sentiment were also disappointing, highlighting concerns about the potential for the peripheral crisis to damage the region’s core economies.

“The last thing the eurozone needs is its largest economy losing steam considering its role as the economic growth engine of the whole region,” said Stefan Angele, head of investment management at Swiss & Global Asset Management.

The global economic picture was also unsettling, with the HSBC/Markit “flash” purchasing managers’ index of Chinese manufacturing activity dipping into contraction territory this month for the first time in a year.

The week’s thin schedule of US economic releases did little to inspire the markets. Instead, the focus in New York was split between the unfolding corporate earnings season and uncertainty over talks aimed at avoiding a US debt default.

Apple, IBM and Coca-Cola unveiled strong results, although quarterly performances from the financial sector were more mixed.

Meanwhile, some signs of progress emerged over talks aimed at raising the federal debt ceiling – thus avoiding default – and cutting the US budget deficit.

The latter point has become increasingly important given that if Washington cannot come up with a credible solution to the country’s future debt burden.

“Republicans and Democrats appear to be inching towards a deal to allow an extension of the debt ceiling but question marks over the potential for a rating agency downgrade are likely unless there is a clear fiscal consolidation programme,” said James Knightley, of ING.

US government bonds pared the week’s losses amid fresh signs of a compromise deal in Washington. The 10-year Treasury yield was up 6 basis points over the five-day period at 2.97 per cent, having traded back above 3 per cent on Thursday. The German Bund yield rose 14bp in the week to 2.82 per cent.

By contrast, government debt yields in Italy and Spain – seen as the eurozone countries most at risk from contagion – dropped sharply over the week.

The Greek two-year yield breached 40 per cent at one stage before plunging back below 28 per cent on Friday.

On the currency markets, the euro bounced off a record low against the Swiss franc and touched a two-week high against the dollar above $1.44.

Global equities recovered from a steep sell-off on Monday. In New York, the S&P 500 was heading for a 2.1 per cent weekly gain while the FTSE Eurofirst 300 rose 2 per cent and emerging market stocks 1.5 per cent.

Gold fell back from a record high of $1,609.51 an ounce but managed to regain the $1,600 level on Friday. In industrial commodities, Brent oil rose 1.2 per cent over the week.