CHINA COMMENTS ADD TO SOVEREIGN DEBT FEARS / THE FINANCIAL TIMES ( RECOMMENDED READING )

China comments add to sovereign debt fears

By Jamie Chisholm, Global Markets Commentator.

Published: March 25 2010 08:54 Last updated: March 25 2010 16:50

16:40 GMT: Growing concerns about sovereign debt found a significant mouthpiece on Thursday, when a senior Chinese central banker warned that the Greek crisis was just the beginning.

“We don’t see decisive actions telling the market we can solve this,” Zhu Min, a deputy governor of the People’s Bank of China, was reported as saying.

His comments caused the euro to dip to a new 10-month low versus the dollar, and encapsulated a nagging worry among investors that high levels of government indebtedness is one of the main risks facing the global economy.

However, the FTSE All-World equity index rose 0.7 per cent and some benchmark stock indices hit fresh cycle highs as investors lapped up Fed chief Ben Bernanke’s reiteration that monetary policy would remain extremely accommodative.

News of a restructuring of Dubai World’s debt , some mildly encouraging US jobs data and hopes for corporate earnings also boosted sentiment towards stocks.

The euro later recovered some poise after the European central bank eased its collateral rules to help Greece, but the timing of Mr Zhu’s statement is particularly pertinent and suggests a fiscal focus will dominate markets for the short term.

Thursday’s Market Menu
What’s affecting risk appetite

Risk on

● Dubai: no haircuts promised in $9.5bn restructuring.

● Euro: tumble halted.

● Whatever!: equities robust in face of soaring $, erstwhile nemesis.

Risk off

● Fiscal focus: sovereign debt worries building....

● ....pushing government bond yields higher....

●....as stocks look toppy at end of quarter.

Of immediate concern is the eurozone. A two-day summit of European leaders convened on Thursday and investors needed to hear that they have been able to knit together a safety net for Greece, lest it has trouble rolling over the €20bn of debt maturing over the next couple of months.

A downgrade of Portugal’s debt on Wednesday and the subsequent tumble in the euro would have concentrated minds, and indeed news was emerging late in the european trading day that Germany and France had agreed a plan to help their smaller neighbour.

But there is a potentially more important issue emerging for investors to ponder. The poor reception given to the auction of $42bn of US five-year notes on Wednesday points to fatigue among buyers of US government debt. If this continues, yields will rise, but not for the good reason – faster growth – but for the bad reason – too much supply. This could knock the nascent economic recovery and hit asset markets, particularly cycle-peak equities, hard.

And who buys most of the US debt? Why, Mr Zhu and his colleagues of course.

● US Treasuries continued to struggle following their pummelling on Wednesday. Yields on benchmark 10-year notes had jumped 15 basis points after the soft auction of five-years, but on Thursday a bit of “bargain hunting” quickly evaporated and yields rose another 4 basis points to 3.89 per cent. This kept yields above equivalent swap rates, signalling investors remain wary of government debt. The auction of $34bn of seven-year debt will be keenly watched later on Thursday.

UK government debt fell back as investors absorbed the implications for supply of the government’s Budget. The yield on the 10-year note rose 6 basis points to 4.03.

Greek debt saw a bit of buying following the ECB’s helpful move and the news out of Brussels. The yield on 10-year bonds fell 7 basis point to 6.27 per cent, while the cost of insuring against default by Athens, as measured by credit default swaps, fell 8 basis points to 319 basis points.

Portuguese 10-year notes saw their yield rise 6 basis points to 4.38 per cent.

● The euro hit a new 10-month low of $1.3285 in Asian trading following Mr Zhu’s comments, but later rose 0.2 per cent to $1.3345. The dollar, which had bounced by more than 1 per cent on a trade-weighted basis on Wednesday, succumbed to some profit taking and was down 0.2 per cent to 81.84.

Sterling initially enjoyed a small bounce following better-than-forecast retail sales for February, but the gains were later erased. The pound was up just 0.1 per cent to $1.482 and lost 0.2 per cent versus the euro to 89.68p.

● US and European equity markets were blissfully unperturbed by the debt market troubles. In New York, the S&P 500 rose 1 per cent to a fresh 19-month high as traders hoped a slight improvement in initial jobless claims pointed to a strong non-farm payrolls number next week.

The FTSE Eurofirst 300 added 1 per cent and the FTSE 100 in London climbed 0.9 per cent to hit a new 22-month high above 5,700. A more stable euro and news of the restructuring of Dubai World’s debt appeared to help sentiment. The Dubai stock market jumped 4.3 per cent, but cynics noted a lack of detail in the Dubai World proposal.

● The FTSE Asia-Pacific index fell fractionally as bourses in the region noted the drop on Wall Street overnight. Shanghai lost 1.2 per cent and Hong Kong 1.1 per cent, though Tokyo managed to advance 0.1 per cent as the yen’s fall to a two-month low versus the dollar helped exporters.

● Gold was firmer after dropping sharply in the previous session to six-week lows as the dollar rallied. The precious metal rose 0.4 per cent to $1,091, but many traders thought it looked vulnerable to a fall through the bottom of its recent $1,080-$1,140 range.

Oil rose 0.7 per cent to $81.17 a barrel.

Copyright The Financial Times Limited 2010.