The positive impact from the EU's €85bn rescue package for Ireland proved short-lived on Monday as investors focused on the risk of the debt crisis spreading to other European countries including, for the first time Italy. However, US investors seemed to find a limit for their anxiety, driving up the price of banking shares and leading US indices to pare their losses for the session. The price of oil also rallied on the day.
Bumpy road ahead for bull markets - Nov-29.Interview with head of IMF mission - Nov-29.Irish banks confirm capital raising plans - Nov-29.Lex: Ireland - Nov-29.Video: Bad news for sovereign states and EU - Sep-01.FT Alphaville: South-facing island for sale - Nov-29..The immediate reaction in Europe to the bail-out was gloomy. The euro fell 1 per cent, to hover near $1.31 to the dollar, as government debt in Spain, Portugal and Italy spiralled higher.
Under the terms of the EU and IMF package, Ireland's banks will receive a €10bn capital injection with €25bn remaining as a contingency fund for the banks. But news that France and Germany had also agreed the outline of a new permanent mechanism to deal with future eurozone financial crises failed to persuade some leading commentators that Europe was past the worst of the crisis.
Mohamed El-Erian, chief executive of fund manager Pimco, insisted the package was not a "game changer" for Ireland. NourielRoubini, an economics professor at New York University, speaking at a conference in Prague, warned that a bail-out will be needed for Portugal and that official funds may be insufficient to bail out Spain if it requires support.
From the US point of view, however, contagion risk did abate to some degree, as the agreements did not, as feared, require a haircut on Ireland's bank bond holdings, a move that had been feared would spark a broader panic
"It might be seen as good news that there were no losses imposed on senior bank debt, and no automatic bondholder loss-sharing provisions for the future," said Michael Cembalest, chief investment officer of JP Morgan Private Bank.
He warned, though, that the issue was not settled: Bail-"outs don't change the level of debt that countries owe, it just shifts the creditors around," he said.
US banking shares rallied to a gain, helped by RBC Capital Markets analysts saying that that Wells Fargo may resume its dividend, and views that a rebound in equity issuance, furthered by banks needing to recapitalise, could help financials. Treasuries also rallied, a further help to financials as borrowing rates stay low, after the Federal Reserve entered its second week of "quantitative easing", buying $7.2bn worth of US government bonds. But gains were muted, as the two-year US bond yield was flat, at 0.51 per cent.
" An active morning gave way to a quiet afternoon as the market digested ... Ireland's bailout and the Fed conducted two buying operations," said William O'Donnell, Treasuries strategist at RBS.
Rates - But the generally unwelcome reception from investors is in sharp contrast to the announcement earlier in the year of the bail-out deal for Greece, which cheered stock markets and sent yields on Greek government debt substantially lower.
Irish debt, which early on Monday had rallied sharply higher, fell back with yields on 10-year Irish government bonds climbing 11 basis points to 8.99 per cent.
Concern about the scale of debt levels in so-called peripheral countries also spread to the Italian government bond markets following an auction that failed to attract strong demand in spite of sharply higher yields. Two-year Italian government bonds jumped 30bps to 2.75 per cent, with 10-year bonds climbing 21bps to 4.61 per cent.
In the auction, the government achieved a bid-to-cover ratio of 1.27 for Italian bonds maturing in 2021, compared with 1.41 in a similar auction at the end of October. The yield was 54bp higher than the previous auction at 4.43 per cent.
Meanwhile, yields on 10-year Spanish bonds, which climbed heavily last week as focus continued to shift from Ireland to Spain and Portugal, hit fresh record highs since joining the euro. Ten-year yields were 25bp higher at 5.41 per cent. Concerns were heightened last week that the European Financial Stability Facility, the bail-out fund created by the International Monetary Fund and the EU in May, may not have the financial firepower to support Spain, the world's ninth-largest economy, should it be needed.
Europe - Irish banks were among the few big gainers on Monday. Bank of Ireland plans to raise €2.2bn of additional capital, while Irish Life and Permanent will seek an extra €98m.
Bank of Ireland's shares rose 16.3 per cent, while Allied Irish Bank was up 5.9 per cent. Irish Life and Permanent soared 58.2 per cent. But earlier positive sentiment across Europe's banking sector faded. Royal Bank of Scotland which had climbed as much as 3 per cent in early trade, is up 0.7 per cent, while Spanish banks Santander and BBVA which were also firmly higher in earlier trade, are down 1.8 per cent and 3.6 per cent respectively.
Equity markets in Europe also pared earlier healthy gains falling firmly into negative territory. The FTSE 100 was down 2.1 per cent and the FTSE Eurofirst 300 fell 1.1 per cent.
Asia - Earlier in the session, Asian equity markets had been led by the positive news on the Irish bail-out which had offset concerns over tensions on the Korean peninsula. Japan's Nikkei 225 is headed for its best month in a year, with the market ending up 0.9 per cent at 10,125.99, its highest level in five months. Hong Kong's Hang Seng index closed up 1.1 per cent to 23,129.19.
Commodities - Gold is up slightly at $1,364.95 a troy ounce. Oil is defying the move away from risky assets and the dollar's strength, rising 1.7 per cent to $85.18 ahead of the American Petroleum Institute's crude inventories report on Tuesday.