At the end of last year it looked distinctly like the global financial system was on the verge of meltdown and that the global economy was about to implode. The change in market sentiment since has been dramatic. Various banking sector bailouts, the pledge of as much as $2 trillion to support the US financial system, passage of the $819 billion stimulus plan by the US administration and G20 agreement pledging $1 trillion for the World Economy, were major events over the first half of the year which helped to turn sentiment around.
More rate cuts by many central banks and expansion of quantitative easing, with the Fed purchasing $300 billion in Treasuries, and the ECB unveiling a EUR 60 billion covered bond purchase plan, provided a further boost to recovery efforts. This was coupled with the passage of US bank stress tests which at least gave some transparency on the state of US banks’ balance sheets.
These efforts appear to be paying off as confidence has improved, data releases especially in Q2 09 have revealed a much smaller pace of deterioration, whilst some US banks felt confident enough to pay back TARP funds, marking a turning point for the US financial sector.
Markets reacted to all of this news positively once it became clear that a systemic crisis had been avoided; most US and European indices, with the notable exception of the Dow ended H1 2009 with positive returns. However, their gains were less impressive when compared to the strong gains in some emerging equity markets, with indices in China and India registering gains above 50% this year as recovery efforts in emerging markets echoed those in the G10, but with the advantage of far less severe banking sector problems.
Currency markets have also given up the high volatility seen at the start of the year as many currencies have now settled into well worn ranges. Measures of equity market volatility have also swung sharply over H1 2009, with the VIX index now less than half of its 20 January peak. Other measures of market stress have undergone significant improvement, with much of this taking place in Q2. For instance, the Libor-OIS spread dropped to its lowest level since the beginning of 2008 and after peaking at close to 450bps in October 2008, the Ted spread has now dropped to a level last seen in late 2007. The change in market sentiment over H1 was truly dramatic but there is little or no chance that this will continue in H2 2009 as I will explain in my next post.