WISE MONEY

European money markets have fallen as the continuing political uncertainty in Greece and Spain undermines investor confidence.Greek President Karolos Papoulias failed to form a coalition government through talks on Sunday and will continue discussions with political leaders on Monday evening.

Bank shares are worst hit, particularly in Spain and France, with Madrid’s Ibex index down 2.8% and the CAC down 2.3%. London’s FT 100 share index is down 1.7% and Germany’s Dax down 2%.

French banks were among the biggest fallers as investors worried about their exposure to other troubled eurozone countries. BNP Paribas was 3.4% lower, Societe Generale lost 3.3% and Credit Agricole fell 3.4%.

Spanish banks Banco Santander and Bankia were down 3.4% and 4.4% respectively, as they said they would set aside an extra £2.16 billion (2.7 billion euros) £1.68 billion euros respectively to meet new government requirements aimed at cleaning up the country’s ailing property market.

Meanwhile, both Spain and Italy carried out successful bond auctions on Monday.

Appetite for Spanish and Italian debt was more than strong enough, but the return demanded by investors in Spain’s debt was higher than in previous auctions, reflecting a dip in confidence.

The difference in the rate demanded by Spanish 10 year bond investors over the equivalent German bunds hit 4.83%, its highest level since the creation of the euro.

The yield, or interest rate, on Spain’s key 10 year bonds, which are traded on the market, jumped 23 basis points to a record high of 6.22%.

Greece’s lack of a government puts in doubt its ability to stick to austerity measures imposed as part of its financial bailout. Without holding to agreed cuts it will not get the rest of the support funds it needs to function.

Adding to the lack of clarity is the fact that anti-bailout parties did well in the elections.

Anti-austerity feeling may be growing in Germany as well as Chancellor Angela Merkel’s party suffered a defeat on Sunday in an election in North Rhine-Westphalia, the country’s most populous state.

The euro suffered again overnight as reports in various papers talking up the possibility of Greece badly missing their deficit targets. The news has caused another shift out of the euro as investors have looked for safer places to invest their funds.

The articles, if proven true, will add yet more pressure onto the rest of Europe with major doubts already surrounding the success of the latest bailout for Greece worsening.

However, unlike when Greece was still seeking this bailout, the US Dollar hasn’t been the sole beneficiary.

Sterling has held its own against the Greenback by slipping back only 1 cent compared to the 3 cents it lost last time.

This is partly due to improved sentiment which was kick-started by the US with strong data realises from their jobs sector.

The UK announced its latest employment figures today with the unemployment rate remaining at 8.4%, a set of results which weren’t too bad.

Apart from this, it is another data light day with little of note being released. We can expect the US Dollar to remain strong as fears being to grow about Greece’s latest bailout.

Europe took a major step towards greater fiscal integration overnight, as all EU members except the UK and Czech Republic agreed to German measures to reduce budget deficits and allow greater oversight by the European commission. The pact should be in place by March with the ratification and implementation to follow shortly after.

Automatic fines of around 0.1% of GDP will be levied on countries who fail to reduce their deficits by the agreed proportions.

The fines smack of a token gesture given it will be one of the PIIGS that fail the tests and clearly they would not be expected to pay, and the fact that the Maastricht treaty imposed broadly similar rules which were blatantly broken by all member states is one of the reasons Europe finds itself in its current state of woe.

As with recent EU meetings, the news will likely trigger a short lived Euro bounce before selling pressure resumes.

Sterling continues to climb against the Dollar driven by the recent surge in the value of the Euro against the Dollar.

Apart from PMI figures, there is little by the way of meaningful UK data out this week to move Sterling so expect it to stay in lockstep with the Euro-Dollar.

Expectations for the PMI data is expected to show a mixed bag, but given the GDP reading earlier in the week there is more chance of disappointing readings than surprises to the upside and that should translate into Sterling weakness.

US data due today and for the rest of the week include personal consumption expenditure which is expected to show a slight increase and ISM manufacturing on Friday is also expected to show a positive reading.

Over recent weeks we have been seeing an about turn in the way the Dollar reacts to positive US data. Over the past few years the risk-on, risk-off theme has been the dominant driver of Dollar movements where good US data was seen as risk-on and the Dollar fell.

Recently we are seeing a reversal in the theme, and positive US data is increasingly leading to the US Dollar strengthening.

The recent rally in the euro was very surprising given the lack of any positive or even specific euro related news over the past couple of days. Market sentiment about the single currency remains low (after a temporary blip last week) because a Greek default is looming ever larger and European policy makers are still arguing over the rules that they hope will make the eurozone less weak moving forward.

In fact short positions (betting that the euro will fall in value) hit record highs over the past couple of weeks, which suggests there recent rally is more about shorts covering their positions, leading to the price of the euro rising forcing other shorts to cover, commonly known as a short squeeze.

If, as is likely, this explains the recent uptick in the euro and so we can expect more euro selling to resume once the squeeze runs out of steam.

Data for the eurozone for the rest of the week is extremely light, with the ECB monthly report showing how much the ECB is lending to stricken banks is due Thursday along with French and Spanish bond auctions.

Both auctions will be closely watched in light of the S&P downgrades on Friday.

Sterling has been fairly steady in the early part of the week.

UK Retail sales are the only release of note for the rest of the week but worth noting because they report over key Christmas period for the retailers and will probably give a good idea to the market if the UK economy is heading for (or is already in) another recession.

The US bank holiday on Monday has meant the US Dollar has also been fairly quiet so far this week, but Thursday and Friday sees a large amount of US data including the CPI figure, which should hopefully give the market an end of week shot of much needed direction in an otherwise rudderless few days.

A new shockwave filtered through the markets on Friday as the credit agency Standard & Poors (S&P)- downgraded France, stripping them of its prized AAA rating. The decision to remove this vital asset in keeping borrowing costs to a minimum left France with a AA+ rating, a judgment that will likely cost billions in higher repayment costs.

S&P said “Europe’s austerity and budget discipline alone were not sufficient to fight the debt crisis and may become self defeating”.

Alongside France, S&P cut the rating of Italy, Spain, Cyprus, Portugal, Austria, Slovakia, Slovenia and Malta though it was expected that these countries would have their ratings lowered.

Overall, the picture isn’t looking good for Europe and with further downgrades likely over the next few months, it will be important to see how the ECB reacts in keeping this ongoing debt crisis under control.

The main winner from this continues to be the US Dollar with further gains against most currencies likely as investors pile more money into the global reserve currency.

For as long as the Greenback keeps this status, it will remain the market leader in these testing times as Europe sits on a knife edge between growth and recession.

There is very little data out today with the only comment of note coming from a speech by ECB President Mario Draghi due at 6pm UK Time.

It is likely he will focus on the downgrade on France and how the ECB will look to repair the damage it has caused.

The wise money markets continue to be driven almost exclusively by extreme changes in sentiment on a day to day basis. The recent euro rally stems from the positive outcome of Spanish and Italian bond auctions yesterday.

Both countries we able to place the bonds at considerably lower rates than in recent auctions lifting sentiment and the euro throughout yesterday and into this mornings trading.

Worryingly data just out showed Spanish Banks borrowing almost €140bn from the ECB in December, almost the record high set back in July 2011 and this tugged sentiment back in the negative direction.

Both central bank decisions were tame affairs, neither the ECB nor BOE changed rates or announced any change to existing QE programs.

For the Bank of England it seems to be a very much wait and see approach before they announce further asset purchases.

Mario Draghi and the ECB can be pleased with the results so far from the LTRO in December.

Confidence seems to be improving in the European banking system because investors now feel the ECB stands behind the banks, and this is translating into lower yields for European Government debt.

The positive US data flow of recent weeks came to a halt yesterday afternoon, with retails sales figures lower than estimates.

This afternoon’s confidence survey will be very interesting to watch to gauge the state of the consumer given such weak retail sale figures and increasing jobless claims this week.

Looking towards next week there is a huge amount of Chinese data to digest first thing Monday.

Positive Chinese data is generally seen as bullish for the world economy, and hence US negative, so the release will probably set the tone for sentiment for the early part on the week.

Europe will remain under the spot light over the next couple of days with the European Central Bank (ECB) meeting today, alongside debt auctions in Spain and Italy. The speculative market is predominantly short EUR while policy makers, specifically German Chancellor Merkel and French President Sarkozy are making the right noises; it appears the penny has dropped for Eurozone officials that it is not only about austerity but also about growth and reform.

Reports that Fitch ratings are unlikely to downgrade France’s ratings this year has provided a welcome boost to Eurozone confidence.

However Greece could yet spoil the party given the continuing dialogue with the Troika to decide the second bailout package for the country.

Political resistance within Greece suggests that more austerity may not be easy to execute.

For the time being there are ongoing questions about the degree of write-downs that Greek debt will endure.

In spite of these issues it looks like investors are becoming more immune to events in the Eurozone. While we still have high bond yields for Italy and other euro sovereigns it seems that risk appetite has improved.

One feature that is providing support to sentiment is the positive news out of the US.

Even though the Q4 earnings season has not started particularly well, data releases look rather more positive.

Last week’s US December jobs report continued to filter through positives to the market and we have also seen a pick up in small business confidence and a rise in consumer credit.

These recent improvements in economic data snaps highlight the gradual recovery process underway in the US and the growing divergence with the eurozone economy.

This supports the view of the US Dollar out performing the euro in the short to medium term.

The volatility that ended 2011 has yet to return the markets with Sterling, Euro and the US Dollar all remaining relatively stable against each other. This may start to change with tomorrow’s central bank interest rates announcements.

Both the Bank of England and European Central Bank are expected to keep rates unchanged at 0.5% and 1% respectively, but the press conference with the newly appointed chief of the ECB, Mario Draghi will be closely monitored.

Any comments about the economic conditions and the ongoing debt crisis in the Eurozone will have a large impact on where the markets move next so no pressure Mr Draghi!

More pressure was piled on the sovereign debt predicament a number of European countries continue to be on many of the credit agencies “negative watch”.

Fitch announced that it is likely to slash Italy’s credit rating at the end of January, which will make it even harder and more costly for the struggling nation to borrow funds.

Spain, Belgium, Ireland, Slovenia and Cyprus are also on the list as the credit agencies remain eagle eyed on how conditions change.

With much of the focus on the Europe and its single currency, expect the US Dollar and commodity currencies like the Canadian, Australian and New Zealand Dollars to remain strong as investors look for safer havens to keep their money during these worrying times.

Further euro weakness could also be on the cards if negative comments are realised on Thursday.

It was akin to a game of chicken as David Cameron jockeyed to protect Britain’s interests from the eurozone’s fatal plans to avoid sinking.  In the end Cameron blocked a crucial EU treaty as he did not get the safeguards that he was looking for.

So where does this leave Britain- isolated or very fortunate?

Politically Cameron has certainly put the cat amongst the pigeons with the Euro a political minefield in a liberal/conservative coalition.

The EU failed to agree Europe wide treaty changes and instead pressed ahead with a fiscal pact for the 17 eurozone nations plus anyone else who is stupid enough and wants to join from the remaining 27.

The Euro area has agreed tothrough good money after bad and make available additional resources of up to 200 billion euro to the IMF, the EFSF leverage will be rapidly deployed.

Private creditors will also be cheered by the removal of previous mandates exposing them to increasing percentage losses via  haircuts- now they are more protected through alignment with IMF principles and practices.

However back to the markets and the response was muted and slightly negative with Italian 10 year bonds rising back above 7pc and the euro unchanged after suffering losses yesterday.

At the moment it is unclear what the new status for the 17+ without a new treaty- on the face of it what we actually have is another stability and growth pact despite the political rhetoric.

In effect it is a step closer to a new treaty and a plan for a plan to move to fiscal unity.

The plan for unity however has been dealt a blow by the profound split with the UK potentially being joined by the Czech republic, Hungary and Sweden.

For the markets we still have unease, uncertainty and division which could spell turmoil for the financial markets.

For the currency markets I would expect that we will see the markets react cautiously as we await more news today.

Elsewhere Chinese CPI came in lower than expected and both Japan and Korea downgraded their GDP outlook.

The markets remain tense as we move into the weekend, even in spite of Italian politicians lending  their support to Mario Monti being appointed as interim prime minister. The markets are hoping that the replacement of current Prime Minister Silvio Berlusconi will be someone who is able to push through reforms that EU, IMF and the markets think Italy needs to bring make its huge debt pile manageable.

So far the key market’s approval verdict- the yields on Italian bonds however have refused to budge below 7.0%.

To compound Euro-zone woes Standard & Poor’s, the ratings agency, mistakenly suggested that it had downgraded France’s Triple-A rating sending yields on French debt markedly higher.

The spread between French and German borrowing rates moved to a new high of 1.7 per cent and the Euro followed suit losing ground against the Dollar and Sterling.

This morning there are reports that the ECB has begun buying bonds in the secondary markets, which is lifting the Euro in early trading.

Money data wise this morning the main focal point will be UK PPI numbers which are important to keep an eye on giving the Bank of England is waiting in the wings to further expand QE either next month or early next year if the economic picture continues to deteriorate.

Most of the financial newspapers are reporting the news that UK gilt yields continue to fall, and that the UK government bond market is now a safe haven for investors.

The market can be very fickle, and it could be a combination of risk aversion and front running the Bank of England that is driving down yields rather than any expression of confidence in the UK economy as a whole.

Today is a bank holiday in America so we can expect very light trading after lunch. Next week sees a large amount of data released on the US, UK and eurozone including German GDP and CPI data in the US.