Spanish 'bailout light' fails to stabilize markets; Greek election buys more time for euro
18/Jun/2012 • Currency Updates•
An initial rally in asset markets and the Euro in response to the weekend news petered out by mid morning Monday. Spanish and Italian bonds spent the week sinking further and further in price. Other asset classes had a mixed week. Equities rose, while commodities and, ominously, German Bunds fell. We think these moves were driven mostly by short covering and do not read much into them: traders’ short position in equities and the Euro is at or near all-time highs, according to futures markets reports. Beyond short-term market technicals, all eyes are now on the Greek election, which as this goes to print appears to have yielded the possibility of a thin parliamentary majority for the pro-bailout parties. Whatever the result, it is clear that dark clouds are gathering around the world, and central banks appear ready to launch a new round of unconventional measures, led by the Bank of England announcement of a 100 billion Sterling facility intended to facilitate the flow of credit to small businesses in the UK.
Last week brought confirmation that the MPC is, as we had expected, increasingly worried about the domestic and international situation. The Bank of England announced a new batter of unconventional easing measures, the most important of which is a joint scheme with the Treasury to fund bank len ding to the non-financial sector at low interest rates and with a long maturity. It also announced further liquidity-enhancing measures, and made it clear that these measures were no substitute for further expansion of quantitative easing. We see this a confirmation of our expectation for a further 50 billion GBP expansion of the Gilt purchase program to be announced at the July meeting.
Economic news in the UK continue to be uniformly grim, however, showing April falls in manufacturing, exports and construction. These data are consistent with a continuation of the recession into the second quarter. In FX markets, Sterling fell slightly against the Euro and rallied against the dollar, but these moves were mostly of a technical nature, as investors awaited the crucial news out of Greece this weekend.
The announcement of a “bailout light” agreement dominated the news flow out of Europe last week. Spain will receive up to 100 billion Euros to recapitalize its banks. Though the financial terms were relatively lenient (rates of 3 to 4 %, and up to 20 years to repay it), there was no direct recapitalization of the Spanish banks – the sovereign will be responsible for repaying the loans. Further,all existing sovereign debt is now junior to the bailout facility. This sparked a series of downgrades by the rating agencies, and a continuous sell off of Spanish bonds during the week. The 10 year yield breached the psychological 7% level on several occasions, though ti managed to end the week slightly below. A new development was that the sell off appeared to extend to German Bunds, in a possible sign that investors are souring on all Eurozone assets. Outside financial markets, news was equally grim, with industrial production falling 0.8% mom saar in April. As we write these lines, it appears that the pro bailout parties will be able to form a Government in Greece, after a marginal victory in the elections over the weekend. We expect the resulting bounce in the Euro to be short lived, and the trend downwards to resume once the massive short euro position in the markets has been cleaned up somewhat.
Macroeconomic data in the United States continues to come out weaker than expected. Last weeks’ disappointment was retail sales, which shrunk slightly in May, Previous month data was also revised lower. Also, industrial production declined 0.4%. We are still optimistic that the drop in energy prices will support consumer spending and keep US growth in 2012 around 2%, but clearly the US economy is proving somewhat more vulnerable to contagion from the European debacle than we had expected. We still look upon the USD as the best of a bad bunch among developed market currencies.