Market Commentary 17th March

As widely expected, the Crimean referendum showed that the overwhelming majority of the region’s population is in favour of joining Russia. There is however a more important question that needs to be answered now, and that is how will Europe and US manifest their discontent with this situation. The challenge is to make their actions meaningful enough to count for Russia while not impairing their own interests. Depending on how the impasse evolves, we might see increasing weaknesses in the countries with stronger commercial links with Russia (e.g. Poland) or higher dependence on Gazprom’s gas (e.g. Germany). However, Europe is reportedly in a good position to withstand a temporary halt in gas supplies as, according to Reuters, the gas inventories are high and the cold weather should soon come to an end. So far, the geopolitical tensions impacted mainly on the equity markets, while the credit markets have been quite resilient benefiting to a large degree from the retreat in treasury yields; reflecting the longer average maturity, the investment grade over-performed the high yield market in the previous week.

This morning we saw a relatively mild retreat in Asian shares, mixed European stocks futures and steady treasury prices. The demand for safer assets might put additional pressure on treasury prices but the short-end of the curve is likely to see limited moves, particularly as the Fed meeting approaches. Indeed, the Fed is expected to move this week to a more qualitative guidance framework which would decrease predictability and, accordingly, make a steep yield curve more difficult to retain. We saw a similar phenomenon in UK, where convincing investors that rates will be low for long became increasing difficult as the unemployment rate neared the central bank’s previously set quantitative target.

The markets could find some comfort today in the 1 trillion yuan investment plan announced by the Chinese authorities. This is meant to redevelop shantytowns, involving more than 4.75 million households and reconfirming the government’s focus on urbanization; a rising urban population is envisaged to contribute to greater domestic consumption and, hence a rebalancing of the economy away from investments and trade surplus. The added clarity on the country’s growth policy could also provide some support to the commodity markets; last week sent energy, copper and iron ore prices lower and put pressure on mining companies such as Vale, Petrobras or Rio Tinto. A second noteworthy piece of news from China regards the widening of the yuan trading band to +/- 2% from +/-1%.

Yet another positive is Moody’s change in its outlook for European Union to stable from negative. The investors’ sentiment could however be dampened if the final Eurozone inflation figures due today disappoint. We are also expecting today industrial production data from US.

Finally, the markets might respond to a note published by Moody’s which concludes that the latest clarifications on ECB asset quality review could put Italian banks under spotlight. Specifically, after ECB disclosed that loan collateral will be market to market, the rating agency expects the Italian banks to experience capital shortfalls.