Global equities continue to rally on eurozone optimism.
Short-dated Spanish and Italian bonds continue to perform strongly.
Bernanke argues that economic indicators might paint too rosy a picture.
The positive market sentiment that started on Friday when financial markets changed their view on the ECB stance and the employment report surprised on the upside continued yesterday and the S&P 500 index was sent to a three-month high at 1,394, gaining 0.2% after jumping 2% on Friday.
The rally in short-dated Italian and Spanish bonds also continued yesterday. The Spanish 2-year yield dropped 44bp to 3.37% and Italian 2-years dropped 7bp to 3.0%. The rally in peripheral debt gained momentum as it became clear that Merkel and her government back the plan announced by ECB President Draghi last week. According to Bloomberg German government spokesman Streiter said that Germany has “no doubt” that the ECB is acting within its mandate.
However, Draghi’s big master plan can still derail. Especially, it seems that the political climate between Italy and Germany has worsened after Italian Prime Minister Monti in an interview with Der Spiegel yesterday said that Bundestag control over EU debt policies threatens to bring about “disintegration” of the EU project. The comments have evoked furious reactions from German politicians. In our view one of the biggest concerns for financial markets at the moment is a political deadlock meaning that neither Italy nor Spain would ask for help.
Even though the rally in equities continued yesterday, US Treasuries managed to perform after two days of decline and yields. The 10-year note fell slightly and is this morning trading at 1.56%. Treasuries were supported by comments from Fed Chairman Bernanke. He said that indicators of strength in the US economy may fail to measure the struggles faced by individuals, indicating in our view that despite the slightly stronger labour market report on Friday the market should be prepared for further stimulus at the September FOMC meeting.
In the FX market EUR/USD trades just above 1.24 this morning. In our view the downside tail risks to EUR/USD have fallen significantly the past couple of days and with still close to record numbers of speculative short euro positions in place according to the so-called IMM positions we continue to see upside for the cross.
After some initial sell-off in both NOK and SEK yesterday, both EUR/NOK and EUR/SEK have once again edged lower overnight. In our view it reflects that both currencies are supported by the positive risk sentiment and that the initial fears of safe-haven unwinds in both currencies were unfounded. We continue to see EUR/NOK and EUR/SEK trading close to current levels despite the eurozone optimism.