FX MONETARY POLICies
A RECAP OF THE LAST THREE HECTIC MONTHS
From September, growing concerns about the euro area debt sustainability overshadowed market participants’ preoccupations with a weakening outlook for growth as the main driver of asset prices. Troughout these months, a run of poor economic data and policy u n c er ta i n t y put pressure on bonds issued by euro area sov e r eig n s with high debt burdens. Greek and Portuguese bond yields rose further, r efle ct i n g difficulties in meeting fiscal targets with their economies mired
in
r e c es sio n . Export growth in Ireland, by contrast, brought yields and credit default swap (CDS) premia down to levels prevailing before the country had resorted
the Facility to multilateral funding
in November 2010. Amid ratings downgrades and political uncertainty, market participants demanded higher yields on Spanish and Italian debt. Even highly rated sovereigns, notably France, saw their yields
32 FX TRADER MAGAZINE January - March 2012
On October 26th euro area heads of state agreed to a three-pronged approach combining debt relief for Greece, leveraging of
and
European the
Financial recapitalization
26th 2011, euro area heads of state agreed to a three-pronged approach combining debt relief for Greece, leveraging of the European Financial Stability Facility (EFSF) and the recapitalization of banks. Te summit announcement triggered a sizeable rally in global financial markets on the
of
Stability banks
increase. Growing concerns over the creditworthiness of Italy eventually led two-year CDS premia to rise above 10-year premia as traders bet on a nearer-term credit event. Te build-up of tensions in bond markets and the associated bank funding problems forced policymakers to seek comprehensive measures for restoring confidence. On October
belief that certain downside risks had been eliminated. While equity and credit markets rallied, the response was more muted in the bond market, as analysts reckoned that the funds to leverage the EFSF would have to come from this same market. Global bank equity and Greek bond prices first strengthened, as the envisaged 50% write-down was smaller than what bond prices and circulating proposals had indicated.
CDS premia i n it ia l ly dropped on the understanding that CDS c on t ra c t s would not trigger under a voluntary debt restructuring. Te rally proved short- lived, however. Even before the surprise announcement of a Greek r efe r e nd um plunged markets into pondering e nd g a me
scenarios on November 1st, market participants were harboring doubts about how these measures would be
implemented. Although the
referendum was cancelled three days later, political uncertainty continued to unsettle markets. On November 9th, dramatic intraday movements
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