Flows, Market Snapshot and Axes…
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The Fed surprised investors in two ways. First, it announced a strong version of Operation Twist. The Fed intends to sell short-term bonds and invest the proceeds in long-term bonds to the tune of USD 400bn.
Almost one-third of the volume will be invested in Treasuries maturing in 20 years or later. Following the announcement, the 30-year benchmark bond yield fell by 40bp to 2.80%. Second, the Fed trimmed its economic outlook. After having stated that “downside risks to the economic outlook have increased” in early August, the FOMC stepped up its rhetoric last week and stated, “there are significant downside risks to the economic outlook, including strains in global financial markets”.
From the minute the FOMC released its statement, financial markets moved in a distinct risk-off mode. Major equity markets gave up more than 7% before a recovery rally helped trim the losses moderately going into the weekend. Minutes of the Bank of England showed that the British Monetary Policy Council is leaning towards more quantitative easing. Business sentiment and purchasing managers indicators released over the past few days underpinned the view that even Germany is facing an economic slowdown.
The risks of contraction during the fourth quarter increased (3Q will benefit from pullback effects after the weakish 2Q). The data scheduled during this week are expected to send a similar message: Ifo index on Monday, GfK consumer climate on Tuesday and EC economic sentiment indicator on Thursday.
Most investors will be cautious in timing the subsequent upswing, which makes it unlikely that risky asset markets will find a bottom soon. With respect to Greece, chances have substantially increased that the country will receive the next tranche in time. The Troika will return to Athens. Greece removed the biggest obstacle out of the way when Finance Minister Venizelos agreed with the cabinet last week to implement further painful austerity measures. In several EMU member countries, the national parliaments will vote on the amended EFSF package this week.. Particular focus will be on Austria (Tuesday), Finland (Wednesday) and Germany (Thursday).
Press coverage of the votes will be enriched with some proposals on how to deal with EMU debt problems made during the IMF/World Bank summit over the past weekend. Overall, market sentiment is likely to remain characterized by elevated nervousness.
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