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Morgan Stanley has a good note out this morning, getting the reaction from various analysts on the panic on both sides of the Atlantic.Here’s Elga Bartstch on Europe:
Likewise, Thursday’s ECB decision to reopen the Securities Market Program and start buying Portuguese and Irish government bonds again seem to have backfired. Not only was the policy action taken by the ECB viewed as “too little, too late” by many market participants, but the decision also revealed a deep rift in the ECB Governing Council. Reportedly, the two German Council Members and two Benelux representatives were against reopening the SMP. The market perception that the SMP does not have the full, undivided support of the Governing Council could undermine the program’s effectiveness, also should the ECB decide to broaden the purchase program to bigger euro-area bond markets, such as Italian BTPs for instance.
More fundamentally, the controversy in the Governing Council raises an important question about the effectiveness of the ECB’s intervention in government bond markets. Under the enhanced rescue mechanism (see Euroland Economics: A Step Forward, But Not a Big Leap, July 22, 2011), bond purchases by the rescue fund would need to be sanctioned by a unanimous decision of all euro area finance ministers. The ECB decision to buy bonds, by contrast, does not require unanimity, as we have already seen last year. True, given its full operational independence enshrined in the European Treaty, the ECB can push ahead with its bond purchases. But, it would do so at the risk of undermining public support for the euro in the core countries. Hence, fending off a bond market meltdown in the non-core countries in the short-term could come at the cost of a rising risk of EMU breakup in the long term.
Jim Caron discusses the impact on interest rates across the curve:
Given the likely demand for front-end Treasuries, the initial reaction could be a steepening of the curve between 2s and 10s. But if there is a sustained sell off in risky assets, then we think there will be a safe haven bid to Treasuries, especially in the belly – 5s and 10s should outperform the rest of the curve. As for the long-end, the experience over the past few weeks has been for the 10s30s curve to steepen over fears of a downgrade. We would expect more of the same. Comparisons to Japan are being made, but we think the situation is quite different. When Japan was downgraded in November 1998 yields rose and the curve steepened, led by the long end. We do not expect a sustained sell-off of that nature in the US.
Hans Rederker on currency:
No doubt, the US sovereign debt downgrade on its own is a USD negative event. But with USD funded asset prices often falling at the same time, the USD may not even be the weakest currency when the markets open tomorrow. The reason is that the weakening global business outlook and EMU crisis complicate currency analysis.
The AUD will suffer. Falling asset and commodity prices puts commodity currencies into a defensive position. The US debt downgrade will increase uncertainties and investors are likely to continue to get more negative on the growth outlook. Consequently, commodity currencies are a “no go area” and are likely to be outperformed by GBP or even EUR.
Adam Parker on Equities:
We believe the market multiple will contract further due to lingering issues related to European sovereign debt, the US debt ceiling, and fears of a China hard landing. Our view is predicated on a belief that growth will ultimately slow and policy will not be a panacea. A catalyst for further multiple contraction will be, in our view, that the profit margin expectations embedded in the consensus outlook are too optimistic.