Global markets cleared a crucial psychological hurdle early yesterday evening in their search for stability when Italian and Spanish bonds rallied strongly on the back of European Central Bank (ECB) buying.
GLOBAL markets cleared a crucial psychological hurdle early yesterday evening in their search for stability when Italian and Spanish bonds rallied strongly on the back of European Central Bank (ECB) buying.
Yields on the debt of both countries fell by about three-quarters of a percentage point to less than 5.3 per cent in early European trading, a huge move. If sustained, it will buy the European Union more time to craft a stronger defence of the two nations, considered Europe's Maginot Line in the fight against sovereign debt contagion.
The European rally was reflected in Wall Street futures, where expected Wall Street losses were halved, albeit to a level that still showed a solid decline in the Dow Jones Industrial Average of 30 blue-chip US stocks.
Finance ministers in the G20 group also issued a statement declaring they would take ''all necessary initiatives in a co-ordinated way'' to stabilise the markets and foster economic growth. But with US sovereign debt ratings downgraded piled on top of Europe's problems, the markets are still focused on short-term developments.
The ECB support for the Italian and Spanish bond markets is mainly about sending a signal that the bonds were over-sold and underpriced. Central bank buying cannot continue indefinitely - and one fear in Europe is that the ratings agencies will now turn their attention to another AAA European economy - France.
Another short-term hurdle was looming overnight in potential downgrades of widely held US municipal, or local government bonds, that are benchmarked against the federal credit rating that Standard & Poor's cut from AAA to AA plus on Friday.
Pimco, arguably the world's most influential bond investment manager, has told its clients, however, that the US government debt markets are ''still the deepest and most liquid in the world''.
It says America's obligation to service its debt is unaffected and the US Federal Reserve has told US banks that they do not need to support the downgraded US bonds with extra capital. The US dollar and US government paper will ''still be the reserve currency and the safe asset due to the lack of an alternative''.
Further out, the highest and most important hurdle looms, in the form of economic data that the US and Europe report in coming weeks and months. The sell-off was triggered in part by Washington's deal a week ago to negotiate an increase in its borrowing limit in return for spending cuts. But the key underlying concern is that the fiscal screws are being tightened at the same time as US economic growth is turning down before its rebound from the 2007-2009 global crisis is secured.
One hope is that weakness in the June quarter reflected a manufacturing supply chain interruption caused by Japan's earthquake and tsunami. But if US growth is as weak as feared, the options are limited.
The US government has already agreed to cut spending, not increase it, as part of its deal to lift its borrowing limit, and the US Fed's key interest rate is already close to 0 per cent.
The fed meets tonight, our time. But its willingness to launch Plan C is going to be tempered by its knowledge that even as the US economy struggles to grow, it is showing signs of reigniting inflation.
Frequently Asked Questions about this Article…
What happened to Italian and Spanish bond yields after the ECB stepped in with buying support?
The article reports that European Central Bank (ECB) buying sparked a strong rally in Italian and Spanish bonds, driving yields down by about three-quarters of a percentage point to below roughly 5.3% in early European trading. The ECB’s intervention was largely intended to signal that those bonds had been oversold and underpriced.
Why does a fall in Italian and Spanish bond yields matter for European market stability?
Lower yields can ease immediate funding pressure and buy time for the European Union to design a stronger defence against sovereign-debt contagion. The article calls the move a crucial psychological hurdle — if sustained, it gives policymakers more room to act to stabilise the region.
How did the European bond rally affect US markets and investor sentiment?
According to the article, the European rally fed through to Wall Street futures, cutting expected losses roughly in half, although futures still pointed to a solid decline in the Dow Jones Industrial Average. The rally helped steady short-term nerves but markets remained focused on near-term risks.
What did G20 finance ministers say and what does that mean for investors?
Finance ministers in the G20 pledged to take "all necessary initiatives in a co‑ordinated way" to stabilise markets and foster economic growth. For investors, that kind of political coordination is meant to reassure markets that policymakers are prepared to respond to widening stress.
How could the US sovereign credit-rating downgrade affect municipal (local government) bonds?
The article notes Standard & Poor’s cut the US sovereign rating from AAA to AA+, which raises the risk that widely held US municipal bonds — often benchmarked against the federal credit rating — could face downgrades. This was flagged as a short-term hurdle for markets.
What did Pimco say about US government debt and the US dollar as safe assets?
Pimco told clients that US government debt markets remain "the deepest and most liquid in the world," that America’s obligation to service its debt is unaffected, and that the US dollar and US government paper will continue to be the reserve currency and safe asset because there is no real alternative.
What economic data and risks should everyday investors watch in the coming weeks?
The article highlights upcoming US and European economic data as key hurdles. Investors should watch growth indicators, since the sell‑off was partly linked to concerns that US growth is slowing while fiscal tightening is under way. The June quarter weakness might also reflect temporary supply‑chain disruptions (for example, from Japan’s earthquake and tsunami).
What is the Federal Reserve likely to do next and how might that influence markets?
The Fed was due to meet and, according to the article, its key interest rate was already close to 0%. The Fed’s willingness to take further unconventional steps (referred to as "Plan C") may be limited because policymakers are mindful that inflation could re‑ignite even as growth struggles. That tension will influence market expectations and volatility.
Call 1300 880 160
Start a chat
Schedule a call
