From Adam Carr, Senior Economist, ICAP Australia:

Sentiment soured again last night, the Vix index pushing up another 6% or so – contagion the word of the moment. There is no new news as such, riots in Greece are continuing and investors are fearfully watching and waiting, reaching for safety where they can.

The PIIGS were messy, aided by a timely announcement from Moody’s that they may downgrade Portugal. Although the EU is threatening to downgrade the ratings agencies by placing them under the supervision of a European markets authority, noting the timing of recent rating reviews is questionable and that the agencies themselves seem to be responding more to sentiment rather than fundamentals – in my opinion a fair point.

So stocks in Athens dropped 3.9% and 2.2% in Spain. Bond yields surged higher – 110bp to 14.91% on Greek 2yrs, 95bp to 5.51% on Portuguese 2yrs and about 40bp to 2.61% on Spanish 2yrs. My view remains that this price action has little fundamental backing and is driven more so by sentiment and news flow. There is a greater probability given the strong global dataflow, that things reverse. Consequently I remain bullish – sentiment can turn sharply, rapidly and I see no reason to change my view because newspapers don’t have anything else to write about.

I think the ECB’s Webber summed it up when he said Spain and Portugal don’t require help the way Greece does, noting both economies will experience positive growth this year and next and have ample capacity to help themselves. Obviously this changes if yields spike to 15% or more. But any move like this would not be fundamentally based. It would be a fear play and become a self-fulfilling feedback loop.

This is what the ECB and others are talking about when they say that contagion risks are real – not because of any fundamental reason, but because of panic. A point I have made myself. A lot of press has been given to these comments, which when you glance at them, paint a picture of politicians and central bankers fearful about the fundamental backdrop (which would apparently justify market moves). But they’re not, they’re worried about panic. They are worried about irrational market moves. So many of these reports are completely out of context. Yet people read them and make an ill-informed assessment of the outlook on them.

For instance there has been a lot of focus on Chancellor Merkel’s comments about how the future of Europe is at stake etc – mega bearish stuff. Yet these comments were made in parliament (as were Weber’s actually) to convince remaining parliamentarians who are hostile (not the majority by the way) of the need to get this bailout through. She doesn’t want, for obvious reason, too much public dissent (many voters are already opposed).

This doesn’t necessarily threaten the bailout though – the latest I’ve heard is that she easily has the numbers to get it through– and even the main opposition themselves have acknowledged the need to pass the bailout package (although they haven’t made a commitment to). So comments made by Weber and Merkel were political, not an assessment of the inevitable failure of Greece or the imminent collapse of Portugal etc or in anyway shape or form a justification for this latest turn in sentiment. It is for these reasons like his that I remain optimistic.

Despite all the pessimism and fear in the press, the market isn’t fully buying into it as yet. The S&P500 is off only 2% in the last 5 trading sessions (5% from its highs). So at this stage it’s only pulled back to its 60-day moving average. A pretty mild correction.

All your editor wanted to add was puzzlement that the European Central bank had agreed to accept Greek bonds as collateral for loans (along with those of other member states) but it would not actually purchase these bonds. This is to conform to the terms of the Maasticht Treaty. Repo 105 anyone?

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