Mercer has recently issued its 3rd Quarter DAA Review, but recent events in global economies and markets warrant an update for our clients. Global equity markets and other risk assets have had substantial falls over the last two weeks, typically falling about 15%, and year to date returns are now negative across the board. Other "risk" assets such as the oil price and the Australian dollar have also corrected significantly and "core" government bond markets have rallied considerably.

Duration: 4:36

Background - Europe

There is rarely a single identifiable event that precipitates this sort of market action, and we believe there are several contributory factors.

Within Europe, the debt crisis has been slowly building for over a year now, but every apparent "resolution" has proved to be very short-lived. The most recent agreement issues by the EU Council on July 21 was initially greeted with relief, but this has been overtaken by the recent rise in government bond yields in Spain and Italy (above 6%), which has threatened their ability to refinance maturing debt issues.

The market seems to be concerned at the "piecemeal" approach of the EU to solving these problems, and the slow moving nature of the EU bureaucracy. Spain and Italy are substantial economies (unlike Greece) and European banks have substantial exposures to these assets. There are concerns that the sovereign bond problem could affect banks' ability to fund, which is an eerie echo of how the sub-prime problems ultimately created the Global Financial Crisis.

There are potential solutions to these problems - the ECB is stepping in to purchase Italian bonds to bring yields down to manageable levels and the EFSF* has been recently granted similar authority. Whether this would provide a longer term solution is open to doubt, and whether the Europeans are prepared to approve such actions is by no means certain. It is understandable why markets are sceptical as to the EU's ability and willingness to control this situation, which is one reason there has been a flight out of risky assets into the safety of German government bonds.

* European Financial Stability Facility