Greek political turmoil continues to haunt risk appetite

With political uncertainty in Greece dominating the news headlines at the start of the week, the euro, peripheral euro area bonds and equity markets took a heavy beating. Greece has so far been unable to form a coalition government and despite Greek President Papoulias’ efforts, no breakthroughs were made in talks between him and key party leaders heading into the second day of talks on Tuesday.

Chinese growth easing weighs on commodity-bloc

Ongoing concerns over Chinese growth also weighed, while Moody’s downgrade of 26 Italian banks continued to hammer risk appetite on Monday. Data from China showed industrial production eased more than expected which ignited concern over an apparent slowdown in the world’s second largest economy. Not even another strong Canadian jobs print on Friday and a rate cut from China could lift sentiment. In fact, despite a 50 basis point cut of their cash required reserves ratio (RRR) by the People’s Bank of China to boost the economy, commodity-linked currencies such as the Australian dollar started the week lower and AUD/USD fell below parity for the first time this year.

With China being one of Australia’s major trading partners, accounting to a record 29 percent in the first quarter this year, economists have raised the possibility of more rate-cuts by the Reserve Bank of Australia, as it moves towards a tighter fiscal-looser monetary policy regime and as China appears to be going through an economic slowdown. Early on Tuesday, the RBA released the minutes from the May 1st policy meeting which highlighted the possibility of an additional 50 basis point Official Cash Rate cut based on weaker economic growth, high inflation data and global uncertainties.

Greece set for new elections

Back to Europe, the common currency area is once more in full crisis mode, as the political situation in Greece continues to deteriorate with the prospect of fresh elections looming. Political party leaders met with the President but fell well short of finding an agreement. Talks were set to resume at the time of writing on Tuesday but with SYRIZA already rejecting the President’s proposal for a government of technocrats, there doesn’t seem to be much scope for compromises. Furthermore, given SYRIZA’s strong opposition to the current bailout terms, even in the slightest possibility that a June election will be avoided, there will still be a confrontation with the EU/IMF. Despite the political tension, close to 70 percent of voters support parties that are against the bailout, a survey showed that nearly 80 percent of Greeks are for the country to stay in the euro zone.

Looking through the shroud of pessimism, some glimmer of light emerged Monday as the crisis in Spain, so far, looked like it had not reached Italy, when measured by the results of the auctions. Spain’s financial sector was becoming of more concern, and the Spanish Tesoro paid higher yields in a short term bond auction. Moreover, Spanish banks borrowed a record €263.5bn from the ECB in April, and 10-year yields climbed to 6.226 percent on Monday, the highest level so far this year.

The Italian Treasury sold a total of €5.25 bln in bonds on Monday, at the maximum target level, including a bond with more than a 10-year maturity. Italy attracted strong demand as concerns over its ability to finance its debt subsided slightly and the sale was the first time in seven months that they sold bonds with this maturity.

Inflation pressure eases in the US

On Tuesday, data published from the United States showed the cost of living was unchanged in April, as a drop in energy prices cooled inflationary pressure. The Labor Department said consumer prices were flat in April compared to the previous month and reinforced the view of some Federal Reserve policy makers that inflation will abate.

The US dollar continued to extend its gains against its major peers, and commodities were increasingly under pressure at the start of the week. EUR/USD dropped to a four-month low by 1.2771 at the time of writing. This drop should give scope to further declines towards this year’s low by 1.2624. The pair needs to close above 1.3000 to regain some bullish momentum.

BoE Quarterly Inflation Report due

The sterling has recently been benefitting from a safe haven status due to actions taken by the Bank of England in keeping monetary policy looser and the government being able to keep fiscal worries contained. However, energy prices have kept inflation elevated and above the BoE’s forecasts. By the time of writing, forex investors were awaiting the quarterly inflation report which was scheduled to be published today at 11:30 CET. A more hawkish stance than expected should see EUR/GBP continue on the offer. The pair hit its lowest level since November 2008 on Monday, by 0.7963. A weekly close below this level could open up for a test of the 61.8 percent Fibonacci-level at 0.7785 of the move from 2007 low to 2009 high.