Euro Debt Crisis Watch

There have been tentative signs of improvement in financial markets over the past few days and volatility has in general declined. That said, many markets continue to trade with elevated risk premiums, high volatility and poor liquidity.  The ECB meeting did not spook markets. The central bank extended its three-month tenders to full allotment during Q3, but did not provide any new information about the debt purchase programme at its monetary policy meeting last week.  Over the past few weeks sovereign spreads have widened again - not only in PIIGS, but also in core countries such as France, the Netherlands and Belgium. Late last week bidding returned to the European sovereign debt markets, but spreads remain wide and in particular Spain is trading poorly.  According to Frankfurter Allgemeine Zeitung, ECB President Jean-Claude Trichet and European Commission President Jose Manuel Barroso are in favour of European financial aid to ease Spain's debt. The story is not confirmed. However, an increasing number of market watchers are mentioning that Spain should ask for an activation of an aid deal in relation to the EUR720bn European Stabilisation Mechanism (ESM).  Evidence of global contagion is mildly encouraging. Money market tensions have eased with the USD FRA/OIS and the FRA/EOINIA spreads tightening. The improvement is also evident in swap and credit markets, but corporate issuance remains very low.  Conditions in covered bond markets in Portugal, Ireland and Spain have worsened further. The problems in the Spanish and Portuguese bank sectors remain an important theme.

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