Nascent 2013 rally gains momentum

After a brief pause on Thursday morning the nascent 2013 rally continued apace and spreads tightened significantly.

Corporates based in the eurozone periphery led the way, assisted by the sovereign market outperforming. Portugal's spreads dipped below 400bps for the first time in nearly two years and are now about 1,000bps tighter than where they were in January 2012.

An unpopular austerity budget was signed into law on Monday, but the Portuguese president yesterday sent the budget for review to the Constitutional Court. If elements of the fiscal package are deemed unconstitutional, then it could hamper its efforts to reduce its budget deficit, a necessary condition of the EU/IMF bailout programme.

However, the sovereign's low spreads indicate that the market believes the government is on the right path and the EU/IMF will continue to give their support. Nonetheless, political risk is likely to be a factor this year.

It will certainly be relevant in Italy, where a general election is fast approaching. Outgoing President Mario Monti announced last week that he would be a candidate in the election in February. Monti's presence has reassured the market, given his commitment to fiscal prudence and structural reforms.

However, the outcome of the election is uncertain, and negative headlines and worrying opinion polls could trigger spread widening in the weeks ahead. Italy's spreads are now trading around 250bps, 38bps tighter than 2012 year-end levels.

Lower borrowing costs for sovereigns were part of a positive picture for the financial markets. The Markit iTraxx Europe was about 4.5bps tighter at 102bps, and is threatening to go below 100bps for the first time since May 2011.

Positive sentiment from the fiscal cliff deal is lingering, though signs of renewed conflict between Republicans and Democrats are already starting to appear. US non-farm payrolls and PMIs tomorrow should provide a welcome, if temporary, diversion away from politics.

Download full article