Markets breathe a sigh of relief after EU summit

Ater tense negotiations the 17 euro countries last week agreed to set up a joint banking supervisory body. The markets reacted favourably, but significant uncertainty continues to prevail. The upcoming financial statements are awaited in suspense.

When faced with mounting pressure, even Angela Merkel can change her mind. Perhaps this is the main conclusion to be drawn after the 17 euro countries recently agreed to set up a joint banking supervisory body (the ESM), which can help recapitalise stricken banks without having an adverse impact on the relevant country’s debt. The agreement means that Italy and Spain are prepared to sign off on EU’s new EUR 120bn growth package and that has appeased the Euro zone’s two new problem countries Spain and Italy – at least for a while.

But although last week’s agreement is good news for investors, dark clouds are still looming over the markets. Uncertainties over the details and specific lending terms of the agreement are significant, and there has still not been found an answer as how to resolve the growth and debt challenges going forward.

Moreover, the past few weeks’ economic data have not exactly been encouraging reading. The US, which has otherwise been seen as a bright spot in the darkness by many investors, appears to have lost momentum and also China seems to have had the wind taken out of its sails. But it is encouraging that both the US and China have launched political measures in an attempt to stimulate growth. The US Federal Reserve has extended Operation Twist under which it intends to buy longer-term and sell shorter-term Treasury securities and China has cut banks’ reserve requirements.

The overall picture here at the end of the second quarter is that the world economy has lost further momentum and has now largely come to a standstill. We do not see any immediate signs of improvement in the coming months. Attention will focus on the upcoming reporting season over the summer, but here too optimism seems to run low. With negative indicators and the absence of upward revisions, investors fear that the reporting season will disappoint. If they are proved right, it will have a strong impact on the markets.

Henrik Drusebjerg
Senior strategist