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10 January 2011

European Yields Continue to Create Market Anxiety

Written by dslmpartners
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Global equity markets decline on lower volumes. In Asia, the MSCI Asia Pacific excluding Japan index declined 1.0%, its lowest level in almost two weeks. Chinese shares also declined, with the Shanghai Composite down 1.6%, amid reports that a new property tax may be implemented in two Chinese cities to curb frothy home prices. Meanwhile, European bourses were lower, retreating from two-and-half year highs last Thursday, with the benchmark Euro Stoxx 600 down 0.7% amid lingering concern that Europe’s debt crisis will continue to spread. The DAX was down 1.3% and the FTSE was down 0.5%. In the US, markets were lower.

Tensions in the euro zone remain the dominant theme in FX markets and should continue to weigh on the euro. German press is reporting that the government may be softening its opposition to expanding the EUR750 billion assistance package.

Portugal’s bonds have been sold-off and there was a clear impact on short-term euro money market conditions when the country announced that it would sell bonds on January 10The more market participants fear that Portugal will have difficulty refunding itself – namely, by paying higher interest rates to fund this year’s deficit, the more investors fear it will become the third euro zone sovereign to require assistance and thus the more likely it will happen. Portugal did raise money in the bill market last week, but at the cost of sharply higher yields. The 6-month bill yield rose to 3.68% from 2.04% in September and a little less than 60 basis points at the start of 2010. Likewise, Portugal’s 10-year bond yield finished the last week of 2010 just above 7.05%. While this may appear to build in a concession that may bring in some buyers at this week’s sale, the risk is that investors will demand even greater yields in weeks ahead.

ECB has reportedly been actively buying bonds, and so bond spreads are not giving a clean read on market sentiment. CDS prices, all of which are significantly higher today for the periphery. Greece 5-year CDS trading at 1067 basis points vs. 1056 basis points Friday, Portugal at 550 basis points vs. 533 basis points, Spain at 358 basis points vs. 352 basis points Friday, Italy at 258 basis points vs. 247 basis points Friday, and Ireland at 656 basis points vs. 622 basis points Friday. These are all at or near record highs despite the Greek and Irish bailouts, despite the creation of the EFSF, despite ongoing ECB bond purchases.

Oil prices moved higher initially moving above $90 dollars a barrel after BP announced that it would have to shut the Alaskan pipeline due to problems. The pipeline shuts in approximately 10% of US production, which is kept offline, will create issues for crude prices.