Risk assets bounce sharply as Spain finally receives a 'bailout lite'
11/Jun/2012 • Currency Updates•
Good news, whether macroeconomic or policy-driven, was scarce last week. However, risk markets, with the notable exception of commodities, were propelled upward on the strength of massive short positioning (all time record shorts in the case of the euro) and hopes that central banks and policy makers will have no choice but to intervene heavily to revitalize the flagging world economy. In any case, the biggest news of the week had to wait until markets were closed for the weekend: on Saturday, Spain requested and was granted up to 100 billion euros to stabilize its failing banks, under conditions that at first glance appear less onerous than the previous bailouts of Ireland, Portugal and Greece. All in all, currencies did not respond with the same enthusiasm as equity markets. We can expect a bounce next week in the euro, as shorts scramble to cover and the markets celebrate the Spanish bailout. All eyes are now on the Greek elections next weekend.
Our view that the Bank of England was likely to loosen monetary policy this past week did not pan out. As is customary when there is no change, no communique was issued, which makes it more difficult than usual to estimate the next move. However, the deepening macroeconomic gloom worldwide leads us to speculate that the decision to hold policy was probably a close and contentious one, and therefore expect another extension of the Gilt purchase program to be announced in the July meeting. The release of the meeting minutes later in the month will be even more important than usual, in order to gauge exactly where the MPC members stand with regards to further monetary stimuli.
As to economic data, there was a glimmer of good news in the PMI business sentiment for services, which failed to drop as consensus expected and managed to hold on near its long term average. However, we note that in the past discrepancies between hard output data on the one hand, and sentiment surveys on the other, have tended to resolve themselves in favour of the former. We therefore continue to expect further easing from the Bank of England, and under-performance of sterling against the dollar, even as it appreciates against the euro.
The big news of the week had to wait until after currency markets closed for the weekend. Spain finally bowed to reality and requested help to bailout its ailing banks. The amount was larger than expected (up to 100 billion euros) and the terms of the agreement were mixed. The Spanish sovereign will be held responsible for the full amount, dashing Spanish hopes of a direct European rescue of its banks. However, it appeared that no further austerity measures will be forced on the country, which is already implementing possibly the most draconian cuts outside of Greece. European officials will strengthen the monitoring of the existing measures, and Spain will relinquish much of its authority over its banking system. Though the bailout conditions are not as bad as we had feared, the existing program of austerity is bad enough. Spanish internal demand is on a state of near collapse, with double digit drops in industrial production and retail sales. Exports are growing nowhere near fast enough to pick up the slack. Other macroeconomic news in Europe were likewise dreadful, with surprising drops in German imports and exports for April, as well as further contraction in industrial production in Italy and Germany. The absence of any significant move from the ECB on Thursday supports the view that European authorities are still adopting a purely reactive approach to the euro crisis, doing the absolute minimum necessary to kick the can down the road for a few months, and therefore we see no reason to change our bearish view of the common currency.
A very light week of data for the United States, dominated by second- and third-tier reports. Nothing emerged to change our view of a spring slowdown in economic growth. This time, however, this slowdown is most visible in business spending and investment data. This supports our view that the European disaster is starting to affect worldwide growth through its impact on business uncertainty and confidence. The fact that the housing sector in the US is not affected to the same degree provides further evidence of this, as this sector is the most isolated from international demand. Overall, we expect that the fading drag from state and local government retrenching, the partial revival of the housing sector, and the eventual renewal of most tax stimuli by Congress will be enough to keep US growth at a moderate pace of 2% or so; not quite enough to make a large dent in long-term unemployment, but sufficient to prevent a double dip recession. We stick with the dollar as the least unattractive of the major currencies.