Market Mover - BNP PARIBAS - Investment Services India

Market OutlookPositive outcome of the EUSummit, althoughimplementation details arelackingFinancial markets continue to be primarily driven by swings in eurozonesovereign risk premia. There was a period of consolidation going into the EUsummits, but the risk-on mode is back after EU leaders’ proposals toaddress the crisis. The most positive aspects of the announcement include:the multidimensional nature of the measures agreed; the agreement inprinciple to 'leverage' the EFSF four to five times the amount still available;the agreement on banks’ capital (bank recapitalisation needs amount toEUR 106.4bn according to the EBA: EUR 5.2bn in Germany, 7.8bn inPortugal, 8.8bn in France, 14.8bn in Italy, 26.2bn in Spain and 30bn inGreece for major recapitalisations); the attempts to settle the Greek issue(on the PSI, the nominal discount on Greek debt will be 50% and theobjective is to reduce the debt/GDP ratio to 120% by 2020); and anotherround of fiscal consolidation measures from Italy.There is still work to do. In particular, the mechanics of the EFSF leverageschemes need to be fleshed out; the ECB is not involved in EFSF leverage;the revision of the July 21 PSI for Greece may encourage more defensivebehaviour by investors; and the proposed reduction in the Greek debt/GDPratio may not be adequate.EMU AAA: Further Normalisation AheadIs this just a post-EUSummit relief rally orsomething more decisive?We continue to favournormalisation tradesSource: BNP ParibasThe measures announced are partly political and some details about theirimplementation are still lacking. However, although these measures may notyet be seen as the final solution (ECB involvement, stronger fiscal union,Eurobonds…) they are clearly a step in the right direction, which should helprestore some confidence in the market. The political acceptance of furtherfiscal measures, particularly in Italy, will be crucial to reduce volatility inEGBs, which remains a pre-condition for investors’ appetite in peripheralmarkets to return.The market reaction so far can be seen as a relief rally on risky assets, witha setback in benchmark papers and a tightening of intra-EMU spreads.Governments need to quickly deliver the missing details (G20 meeting3-4 November) and to implement further fiscal reforms to sustain the moves.We favoured normalisation trades going into the Summits and we maintainthis call for the weeks ahead – expecting further bear steepening on thebenchmark curve and tighter EMU spreads. A more defensive way to bepositioned on AAA curves after the post-EU Summit’s sharp move onspreads could be 2/10s OATs flatteners versus 5/30s DSL steepeners as2/10y OAT/AAA boxes have reached extreme levels.Beyond the coming weeks and our call for further normalisation, bear inmind that although EMU news has set the tone for several weeks, the otherCyril Beuzit 27 October 2011Market Mover2www.GlobalMarkets.bnpparibas.com