Spanish bailout optimism fades as Greek elections loom
Spain became the fourth euro zone nation to seek financial assistance over the weekend. Risk appetite responded favorably to the news and the euro opened much higher to rally to a three-week peak against the dollar. Equity and fixed income markets opened the week on a strong note, and higher-yielding currencies also surged higher. Over the weekend, Spain secured as much as 100 billion euros to ensure the survival of its banking system. The news had appeared to have given the area some respite as investors got some re-assurance that Europe was committed in tackling its debt crisis. Sentiment was also lifted by trade data from China which was less pessimistic than markets were expecting.
Despite the positive start to the week, the Spanish sovereign bond market reacted negatively to the bailout announcement which was aimed at recapitalizing the Spanish banking system. Italian bonds also came under fire with the ten-year yield rising by 26 basis points to close above 6 percent, the highest level this year. Spain’s bailout ignited concerns over the risks of contagion to other indebted nations. This pushed Italy back into the spotlight as it was being seen as next in line to succumb to the debt crisis. Furthermore, investors remained skeptic ahead of a crucial vote in Greece over the weekend which will decide the fate of Greece’s future within the bloc.
Also on Monday, official data showed that Italy’s economy shrank 0.8 percent in the first quarter of the year, compared to the last quarter of 2011 confirming a preliminary reading, but annual GDP figure was revised lower compared with the same period last year to -1.4 percent versus -1.3 percent.
All this was too much to bear for the single currency. The turnaround in market sentiment was provoked by worries that the ESM’s preferred creditor status could trigger a CDS event if this vehicle is used to fund the bailout, and investors found little consolation from reports which suggested the funds could be directed through the EFSF before reaching Spain to avoid this seniority problem. More importantly, the International Swaps and Derivatives Association (ISDA) declared that the rescue proposal is not likely to trigger a credit event through subordination, which helped stop the bleeding. Ratings agency also sounded somewhat positive to the news. Standard & Poor’s said that Spain’s sovereign rating was unaffected by the bailout announcement and also proclaimed that even if Spain made full use of the aid allotment, this will only take government debt to above 80 percent of GDP.
EUR/USD gave back all of its gains throughout Monday. The pair fell to 1.2451 on Tuesday after hitting a three-week high by 1.2669 early on Monday. EUR/JPY also rallied to a three-week high to 100.92 at the start of the week, but dropped as low as 98.72. The AUD/USD also plummeted to end the day lower than Friday’s close on Monday. The Aussie traded briefly above parity by 1.0008, but plunged to close by 0.9863. By the time of writing on Tuesday, the euro and other riskier currencies had steadied and pared some of the hefty losses suffered on Monday. EUR/USD recovered to hit 1.2529 while AUD/USD was up to 0.9936. EUR/JPY was also lifted, and reached 99.79 on Tuesday.
The outlook for the single currency however remains bleak in anticipation of Greece’s election results, with forex investors expected to add to dollar and yen longs, as appetite for riskier currencies fades in favor of ‘safer’ assets. An electoral victory for those parties opposing the austerity package negotiated under the nation’s bailout could trigger a sharp decline for the common currency, and push it to lows not seen since 2010 and test a two-year low by 1.1876 against the greenback.
Central Bank Meetings in focus
This week is another important week from the monetary policy front. On Wednesday the Reserve Bank of New Zealand is expected to announce no change to their current policy rate of 2.50 percent. Switzerland and Japan’s central bank meetings scheduled for Thursday and Friday respectively are of significantly more importance. The Swiss National Bank will announce its decision regarding the floor on EUR/CHF which is currently set at 1.2000, with speculation for the raise of the floor to 1.2500 still very much alive. The Bank of Japan’s meeting will also be very well anticipated especially in the light of remarks by the International Monetary Fund on Tuesday, that the Japanese yen was moderately overvalued, and policymakers should consider adding more stimulus.
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