There will be major uncertainties surrounding the Euro-zone outlook with an increasing focus on Spain and Italy as well as the Greek election. There will be fears surrounding Greece’s outlook even if the pro-austerity parties secure a victory in the election. There will also be speculation that Spain and Italy will move closer to requiring sovereign bailout funds. There will be strong pressure for a shift in German policies and there will also be strong pressure for a more aggressive ECB stance on monetary policy as policies remain unsustainable. In this environment, the Euro will find it difficult to gain more than limited relief.
Although Spanish fears increased again, the Euro was able to recover from lows near 1.24 against the dollar during the week with pressure for a covering of short positions compounded by some hopes that the Greek crisis could ease following the election.
The Spanish banking-sector bailout inevitably remained a very important focus following the weekend agreement. There was a sharp initial decline in Spanish 10-year yields to below 6.0% for the first time in three weeks before a sharp reversal.
There were uncertainties whether the bailout funds would be made available through the EFSF or the ESM and there were important reservations surrounding the ESM. Assuming the fund is ratified by all national governments and brought into operation as planned at the beginning of July, there will also be further fears that any use of ESM funding would subordinate existing private bond holders. This would lessen the attractiveness of Spanish sovereign debt.
There was significant friction between Italy and Austria following Austrian Finance Minister Fekter’s remarks that Italy could require assistance. Although Fekter looked to tone down the rhetoric after the Italian government criticised the comments underlying tensions remained high.
Spanish Prime Minister Rajoy also called for a battle to be waged to solve liquidity and funding pressures with the government sounding increasingly desperate. The latest Euro-zone industrial production data was close to expectations with a 0.8% April decline. There will be further pressure for more aggressive monetary policies with Nowotny suggesting that further ECB interest rate cut could be considered.
Moody’s cut Spain’s sovereign rating by three notches to BAA3 and warned over further potential action. Following the Moody’s downgrade there was another rise in Spanish bond yields as benchmark 10-year yields briefly rose to the 7.0% level. This is an important level for sentiment with fears that a rise above this level will push Spain towards a wider sovereign bailout. There were reports that the government held emergency talks about the economic situation. Italian yields also rose during the day with three-year yields rising to 5.30% at the latest auction from 3.90% previously.
The Greek elections also remained an important focus and there was some speculation that private opinion polls were suggesting a victory for the New Democracy party. This eased fears over a victory for Syriza with some optimism that the government would maintain a commitment to austerity policies which would lessen the immediate threat of a Euro-zone exit. There was also expectations that the Euro-zone could revise the terms of its austerity package. Although confidence remained very fragile, there was a further incentive to pare speculative short Euro positions.
Yen:
Defensive considerations will remain very important and there will be further safe-haven yen demand when risk appetite deteriorates, especially with markets very uneasy over the fundamental outlook in other major economies. There will also be pressure to maintain regional competitiveness which will reinforce pressure for yen gains to be resisted, especially if there is a weaker tone for the Chinese yuan. There will be an important lack of confidence in longer-term Japanese fundamentals which will should limit the potential for yen gains and there will also be further speculation over intervention to curb any gains.
There was underlying yen demand emanating from underlying Euro-zone fears which prevented a dollar move to above the 80 level. There was caution over pushing the yen aggressively stronger, especially with unease over the threat of official intervention and the possibility that the Bank of Japan would announce further quantitative easing at this week’s policy meeting.
The IMF also stated that the yen was still moderately over-valued and that the Bank of Japan should consider additional stimulus.
The central bank held interest rates steady at the latest policy meeting and also left the amount of quantitative easing unchanged. Although the decision had been expected, there was a further yen advance to the 78.80 region following the decision and the Japanese currency was able to regain some ground against the Euro. |