So now we head into the final month of the year with many investors still hoping for a Christmas rally. For that to happen, we need to see confidence return to the European bond market. Yields need to fall generally, while the spreads of Spanish, Italian and French bond yields over those of German bunds need to narrow substantially. Hopefully any compression won’t be the result of another sell-off in German sovereign debt. Market participants remain fixated by the euro-dollar pair. The single currency fell sharply last week, breaking back below $1.33. Thursday saw another downgrade for Portugal, and on Friday, Moody's cut Hungary’s credit rating to junk status. Austria – one of only six AAA Eurozone countries – will feel the effects of this downgrade due to its banks’ large exposure to Hungary.
Yesterday we saw a sharp rally across all risk assets. This followed a report in the Italian press that the International Monetary Fund (IMF) was ready to bail out Italy. Although the IMF was quick to deny the story, traders were forced to cover short positions in the single currency and equities. The question now is whether this rally is sustainable or not. But while rumours can move markets in the short-term, they cannot change overall sentiment. This remains negative for now, and is likely to stay that way in the absence of radical political change in Europe.