Focus Back on EU Debt Crisis & Policy Makers Approach
With European sovereign debt concerns re-emerging, risk aversion has been the dominate theme as the Forex market opens this week. Asian regional equity indices were marginally lower as the USD gained across the board (S&P 500 managed to climb +0.56% close on Friday). An FT article stated that the ECB’s Trichet had inched back on this view that in some cases EU bonds in default could be consider as collateral. The ECB’s semi firm commitment to accept bonds in default had previously offset some of the credit agencies downgrades. Trichet stated “the ECB could not accept defaulted bonds as collateral” and that “other EU governments would have to come up with ways to keep Greek banks in business if they continued pushing for a bail-out plan that would lead to bond defaults.” However, with Trichet saying the bank couldn’t accept defaulted bond as collateral, participation in peripheral debt markets took on a significantly greater risk. The feeling was quickly transmitted into yield spread and CDS which continued to show further signs of stress. In the 5yr CDS, Portuguese hit a record high of 1,190bp up 62bp on the day, Italy all time high of 325bp, Spanish now at 370bp, Greek 2,525 up 130bp on the day, Irish stands at 1,170bp.

EURCHF gapped lower hitting 1.1365 and USDCHF dipped to 0.8033 illustrating the draining confidence the market has in EU policymakers’ ability to develop a solution to investor’s growing concerns. Friday’s EU bank stress test revealed that 8 out of 90 European banks (Portuguese, Italian, and French all passed by large margins…really?) failed the test, however the relevance and methodology of the test were rigorously questioned prior and risk appetite failed to firm on the questionably positive news. For example, the stress test reported that there was a gap of €2.5bn compared to many analysis expectations that roughly €120bn that was actually needed. I’m no number wizard, but a divergence that wide is a big difference.

Interestingly, the report shows that a vast majority of Greek debt was held by Greek banks, roughly 67%, with the other largest holdings being German followed by French banks. The date for the EU summit geared specifically to discuss problems/solutions for Greece and Eurozone is now set for Thursday July 21, ending days of speculation. We suspect that the market’s “goodwill” toward EU policymakers has all been but tapped and they need to make the most of this meeting. To add to the view that credibility issues will continued to plague this current wave of the crisis, FT reported that Germany’s Merkel would only travel to the summit if an agreement on a new rescue plan for Greece has been reached. European fiscal tensions will continue to drive FX price action and will inevitably hold the market’s attention through this week.

In New Zealand, CPI inflation for Q2 jumped to 5.3% yoy vs. 5.1% expected, hitting a 21 year high. The NZD reacted positively to the read climbing to 0.8479 but Euro/risk sell off pushed the pair lower. The CPI print was significantly higher than the RBNZ target 1-3% band and supports the theory that more aggressive tightening is in the works. However, the RNBZ Governor Bollard has reportedly stated that he views the current pressure as transitory and is unlikely to raise rates till spring 2012, unless there is indication that inflation is entrenching itself.

That said, both Moody’s and the S&P put the US’s AAA rating on negative credit watch last week, a figurative “shot over the bow” for investors, signaling that the USA is also struggling with its own fiscal problems. The debt ceiling has been weighing on investor sentiment as the University of Michigan consumer sentiment dropped to 63.8 vs. 72.2 exp on Friday. We are anticipating that Congress will agree to raise the debt ceiling $2.4trn this week, which should in the short-term, be perceived as USD positive. However, it’s only a matter of time before the US must address their own fiscal demons.