OREANDA-NEWS. April 16, 2012. Economic fundamentals in the eurozone remain weak and are likely to deteriorate further as a result of the contractionary policies adopted by EU governments, reported the press-centre of ATON.

Moreover, we see a risk of stagflation in the region. Although the ECB could provide some support for growth, its efficiency might be limited (due to weak confidence among consumers) and it is unlikely to provide such support under its current mandate, which places a higher priority on price stability.

Sentiment in global markets currently looks upbeat, but fragile. High-yielding instruments are prone to the formation of bubbles in an environment of abundant liquidity, while demand for insurance hit multi-month lows in 1Q12.

US fundamentals are improving but we see evidence that the 1Q12 financial markets rally was fuelled by expectations of QE3 in 3Q12. As this prospect is now fading away, we see the risk of a price correction.

Large volumes of bank bond redemptions in the eurozone, as well as an intensive sovereign debt repayment schedule in 2Q12 are likely to intensify liquidity pressures.

Russia’s economy seems to be operating slightly above its potential but downside risks remain, especially as the sensitivity to downward oil price movements is much higher than to upward movements. The Ministry of Economic Development recently revised its GDP estimate down to 3.4% in 2012 (from 3.7% before) despite an upward change in its oil price forecast from USD 100/bbl to USD 115/bbl.

While we do not expect any major oil price shocks in the near future, the high sensitivity of Russia’s economy to downward shifts in crude prices leaves it vulnerable to adverse developments in the commodities markets. A declining share of non-O&G revenues in total budget revenues and higher volatility in the rouble exchange rate are the key risks, in our view.

We believe the rouble has limited appreciation potential and is effectively ‘capped’ at RUB28/USD. However, its downward sensitivity to potential adverse developments in the commodities markets increases as the CBR moves towards greater exchange rate freedom.

n Our general recommendation for 2Q12 is to stick to special situations in bonds, which may serve as protection against market volatility and uncertainty. These situations include callable bonds, short-duration bonds, high-coupon bonds, defensive bonds and bonds with short-term triggers. For clients who hold a more bullish view on the market, we present a list of trade ideas based on mispricing.