Recovery in Europe still hampered by low domestic demand – Interactive Data

Despite the two-speed eurozone, Spain and Ireland revealed plans to exit their bailout programmes, Interactive Data’s latest commentary highlighted.

In November, financial market sentiment was cautiously positive. Stock indices continued the upward trend from recent months and were generally higher as indicated by global indices. The S&P Global rose 33 points to 1522. In Europe, the German DAX went up from 9033 to 9405 points on the month. The UK’s FTSE 100, heavily loaded with commodity companies, was down 81 points to 6,650, also on the month. The credit indices continued their downward move from previous months with the iTraxxTM Crossover 5yr index hitting 284bp, the lowest level this year.

In Europe, after low inflation of 0.8% published by Eurostat at the end of October, markets entered November speculating on a possible interest rate cut. The ECB did not disappoint and lowered interest rates on November 7 to a historical low of 0.25%. Further macro data posted later in November confirmed the downbeat economic backdrop. Eurostat revealed that August eurozone industrial production index fell 0.5% to just over 100 points and is still below post-crisis peak of 104 points in September 2011. This was followed by disappointing 0.1% Q3 GDP growth from the eurozone with French, Italian and Spanish Q3 GDP decreasing by 0.1%, quarter on quarter.

France was also downgraded one notch by S&P to AA. ECB board members began to talk of further action to support the fragile eurozone recovery; negative interest rates as well as a new long-term liquidity operation (LTRO), were mentioned by media as possible tools.

Despite November’s inflation being slightly higher at 0.9% and unemployment in the whole eurozone being lower, recovery in Europe is still being hampered by weak domestic demand and high unemployment in peripheral eurozone countries where businesses are struggling with a strong Euro.

Recent positive signs from the UK and Germany further highlight Europe’s two-speed economy. UK’s services PMI for October rose to 62.5 from 60.3 in September and the OECD increased the country’s GDP growth forecast for 2013 from 0.6% to 1.4%. The steady increase of house prices in the UK prompted the Bank of England to announce plans to start scaling down its Funding for Lending Scheme. This will now be refocused on lending to businesses from January 2014. The UK 10yr benchmark yield jumped 15 basis points, from 2.62% to 2.77%.

In the same vein, German October manufacturing PMI was higher at 51.7 compared to 51.1 in September and the official German Harmonised Index of Consumer Prices rose to 1.6% from 1.2% in October; both are supportive of the EU inflation backdrop. Germany’s record €18.8bn trade surplus in September, however, has been a lightning rod for criticism as such a big trade surplus in the long run will hamstring recovery in other eurozone trade partners. The German 10yr benchmark yield was generally unchanged at 1.69%, but the shorter end was slightly lower, in line with other European government yield curves.

Despite the two-speed eurozone, Spain and Ireland revealed plans to exit their bailout programmes. Ireland said it would exit its three year €85bn programme in December while Spain, would leave its €41bn bailout as of January 2014; both countries achieving exits without precautionary funding. Spanish 10yr benchmark bond yield was up over 7bp to 4.13% on the month and the Irish 10yr benchmark was up 3bp 3.52% on the month. The Italian 10yr benchmark bond yield dropped 11bp to 3.90% and the French 10yr benchmark bond yield was lower on the month by 2bp to 2.23%. European sovereign curves steepened, suggesting investors expect the recovery to continue and future interest rates to rise.

Emerging Markets
After significant gains in October, emerging market debt started November well, but yields subsequently rose on fears that the US Federal Reserve may begin tapering their stimulus program. The yield on the South African rand 10yr benchmark increased from 7.6% to 8.01% and the yield on Indian rupee 10yr benchmark rose from 8.47% to 8.67% on the month, also pushed up by uncertainty over Indian inflation.

The Ukrainian parliament, under political pressure from Russia, voted against an association and free trade agreement with the EU. The Ukrainian opposition led by Vitaly Klitschko, staged protests in the Ukrainian capital, Kiev, demanding the resignation of the prime minister. The 10yr government dollar denominated benchmark yield rose 33bp on the month, to 10.01%.

Overall, emerging markets new issuance has continued strongly from last month with 2013 turning into a remarkable year with last year’s supply of around USD169.7bn poised to be broken. Croatia sold $1.75bn of 10yr bonds at a yield of 6.2%, below initial price indications of 6.5%. Serbia issued $1bn 5yr at a yield of 6.125%, significantly more expensive than a similar deal sold in February at a yield of 5.15%, indicating some push-back on risk appetite towards the end of this year.Corporates
European corporate bonds spreads ground tighter and credit indices dropped throughout November, though at a slower pace than in October. Data provided by Interactive Data’s CDS Evaluations Service shows the iTraxxTM Senior Financials 5yr index fell 19bp to 86bp and the iTraxx Sub Financials 5yr were down 28bp to 132bp. The iTraxx HiVol 5yr index adjusted down 18bp to 99bp and iTraxx Crossover 5yr index slipped 15bp to 284bp.

Spanish oil producer Repsol has reached an initial agreement with the Argentinean government over the nationalisation of YPF. Negotiations have been going on for over a year. The Argentinean government will pay $5bn in bonds, less than Repsol had demanded. Repsol’s senior 2023 bond yield dropped in November 10bp to 3.74%.

Co-operative Bank
In Financials, the Co-operative Bank admitted it could take the UK institution up to five years to return to profit. The bank also announced plans to cut its branch network by around 15%. Adding to the negative sentiment on the name, the former chairman of the Co-operative Bank was then arrested days after he was filmed by a newspaper handing over £300, allegedly for cocaine and other illegal drugs. The bank has also been criticised for making payment of £1.1m to two key executives in charge of units, blamed in part, for the bank’s £1.5bn capital shortage. Co-operative Bank’s senior 2017 bond yield rose 30bp on the month, to 5.44%.


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