Markets, business climate and legal environment

Capital markets

Central banks in the United States and the Eurozone pressed ahead with their extremely relaxed monetary policy in 2010. The US Federal Reserve left its key interest rate unchanged at virtually zero. In the third quarter the decision was taken to invest funds from maturing instruments in US treasury bonds. This was followed in November by the announcement of further monetary policy expansion through the additional purchase of government bonds. Altogether, the Federal Reserve is looking to buy up the equivalent of roughly USD 900 billion by the summer of 2011. These unprecedented steps were prompted by the fear that the US economy could slip back again into recession.

Similarly, the European Central Bank also kept its foot on the gas in 2010. The prime rate was left unchanged at 1% and tender transactions were awarded in full. Not only that, the ECB also began to buy up government bonds. As justification for this move, hitherto unprecedented in the history of the ECB, the temporary impairment in the proper functioning of the markets was cited: the purpose of these measures is not to extend the money supply, but rather to hold it on a constant level through offsetting transactions.

After an untroubled first quarter in which yields moved sideways, the debt crisis affecting countries on the Eurozone periphery took center stage in the following months. This prompted a flight to low-risk asset classes among market players. The market for government bonds issued by AAA-rated core countries, especially Germany, profited from this development. The risk aversion displayed by market participants caused yields on 10-year government bonds in the Eurozone to fall to levels barely above 2% on multiple occasions between April and August. Parallel to this, risk premiums for government bonds issued by peripheral Eurozone countries increased sharply. While the extensive bailout packages repeatedly served to calm markets for the short term in the period that followed, the skepticism prevailing among market players remains very high overall to this day.

Yields on 10-year government bonds in 2010
Linechart: Yields on 10-year government bonds in 2010

In conjunction with implementation of a Bank Reorganization Act in Germany at the beginning of November, the market segment for financial bonds also saw a significant increase in risk premiums. Since developments on the economic side were looking brighter, particularly in Germany, yields rose sharply in this period on the interest rate front. 10-year German federal government bonds listed just below 3% at year-end. All relevant euro bond markets closed the year with a positive performance.

Movements on equity markets in 2010
Linechart: Movements on equity markets in 2010

Movements on equity markets in the developed countries were driven by the sovereign debt crisis in 2010. A brief period of consolidation at the beginning of the year was followed by an upward movement from February onwards, although this quickly came to an end as the second quarter got underway owing to the emerging sovereign debt issues. Prices then moved sideways until the end of the third quarter. The closing quarter of 2010 ushered in a year-end rally in which almost all indices reached new highs.

The varying economic developments were reflected in the equity indices. The strong performance of the German economy carried over to the DAX, which closed the year with a performance of +16%. The Euro Stoxx 50, on the other hand, performed weakly in the course of the year on the back of the sovereign debt crisis affecting Eurozone peripheral countries and recorded a negative performance of –2%. The S&P500 Total Return beat the previous year by 14%.

While economic worries proved to be a drag on stock markets, the abundant supply of liquidity provided by central banks as well as – most significantly – surprisingly strong corporate profits and increased M&A activities were positive drivers. The successful outcome of the stress tests performed on banks at the start of the second half-year was also a source of relief.