1/ GET REAL
It may lack key details and depend on wealthy foreigners dipping into their pockets, but the euro zone deal on Greek debt has proved a fillip for riskier assets. More clues to whether the likes of China and Brazil are willing to participate in the bloc's bailout fund may emerge at the G20 leaders' meeting in Cannes, France, on Thursday and Friday. But with the debt crisis off the boil for now, markets are likely to focus in the coming week on the real economy, with monetary policy decisions from the U.S. Federal Reserve and the European Central Bank before the always keenly-awaited monthly U.S. non-farm payrolls report on Friday. After data showing the U.S. economy grew at its fastest pace in a year in the third quarter, the Fed is likely to wait for more evidence of the efficacy of its Operation Twist bond-purchase program. By contrast, the ECB, with new President Mario Draghi in charge for the first time, may flag a rate cut. If it does not and the U.S. jobs report disappoints, the positive sentiment that greeted the euro zone deal, and the riskier assets it supported, might wane and risky asset could well come under pressure.
2/ SHOW ME THE MONEY
The rally in higher-yielding euro zone government bonds appears fragile with long-term investors sidelined as they await details of how the European Financial Stability Facility is to be leveraged and on how far China and others are willing to shoulder part of the financing of the rescue fund. Yields on bonds from Italy are still above levels last seen in early October, when Germany and France pledged a sweeping solution to the crisis. Although it is still early days, bond and credit prices also reflect market skepticism that the private sector involvement in the Greek bailout provides enough of a firewall: Greek credit default swaps indicate an implied 90 percent probability of default while debt prices are still discounting a haircut of more than 60 percent, compared with the 50 percent loss the financial sector agreed to take on investments in the country's debt. Given the PSI model in Greece's case was viewed as a potential template for any other bailouts that might be needed, market focus will return to Portugal as it is seen to be in a more precarious position than Ireland. Portuguese 10-year bonds are trading at about 50 cents in the euro with its CDS near historic highs at 1,100 bps, and these may deteriorate more as the market prices in the prospect of an eventual bigger haircut for Greece. These outstanding issues as well as expectations that Spain will miss its 2011 deficit targets, could make for a difficult environment for Madrid's next round of debt auctions on Thursday.
3/ LOOKING TO DRAGHI
Financial markets will be especially attentive to the European Central Bank policy meeting on Thursday as it will be Mario Draghi's first as president after taking over from Jean-Claude Trichet. Markets will be keen to hear how soon Draghi may signal an interest rate cut given the batch of data showing a growing risk the euro zone may be tipping into another recession. A dovish Draghi could see money market traders firming up bets on a rate cut by December, which had been scaled back after the October meeting when Trichet was perceived to be less dovish than markets had expected. If the ECB flags near-term interest rate cuts, the euro could come under pressure, with the German yield curve likely to steepen further. Draghi will also come in for questioning on how long the central bank intends to pursue government bond purchases in the secondary market after he assured markets that the central bank would go on buying the debt even as EU leaders were trying to hammer out measures to leverage the EFSF, which is intended eventually to take over that role. The central bank could be forced to boost the size of its bond purchases if Italian and Spanish yields climb above the 6 percent level beyond which borrowing costs could become prohibitive.
4/ INTERVENTION JITTERS
The dollar's steady drop against the yen to fresh record lows will keep alive intervention risks. But the recent strength in the yen has been due to dollar weakness, so any Japanese intervention ahead of the G20 meeting will be a hard sell to international policymakers. Focus in currency markets will be on the FOMC meeting with speculation running high that the Fed is prepared to flag a more dovish bias, in which case the U.S. dollar could come under more pressure. Dollar/yen risk reversals are moving more in favor of yen calls -- more upside risk for the yen -- but near-term implied volatilities are also climbing, reflecting nervousness about possible intervention. The dollar's weakness is lending support to the euro whose correlation with the S&P 500 stocks index has strengthened in the past few weeks while its link with two-year German and U.S. government bond yield spreads has waned. That relationship could come back into focus in the coming week if the ECB flags near-term interest rate cuts.
5/ LACKING MOMENTUM
Even if the euro zone deal can eventually resolve the debt crisis, the longer-term prospects for companies and equities remain gloomy. The outlook for European, U.S. and Japanese companies' earnings has worsened. For example, European companies' earnings momentum -- analysts' upgrades minus downgrades as a percentage of total estimates - has fallen to -19.8 percent from -16.2 percent a month ago. The third-quarter earnings season has also been grim in Europe so far, with more companies missing market expectations than those meeting or beating estimates. However, some will argue that it is still early in the European results season and that things may turn around. In the coming week, Barclays, Credit Suisse, BNP Paribas, RBS, BMW, Alstom, Commerzbank, Imperial Tobacco, Adidas, Swiss Re, Unilever, Pfizer and Kraft Foods are among the companies reporting. For the latest updates on the stock market, visit Stock Market Today For the latest updates PRESS CTR + D or visit Stock Market news Today
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