FUNDAMENTAL OUTLOOK at 0800 GMT (EDT +0400)
USD
The euro initially weakened after Moody’s cut Greece’s sovereign rating by three notches to Ca, taking it one notch above the lowest possible rating. FX markets had earlier made a volatile start to the week in Asia after the latest round of negotiations on raising the US debt ceiling broke up acrimoniously and, crucially, without agreement over the weekend. EURUSD traded 1.4343-1.4417 and USDJPY 78.12-78.56. Gold hit a new record high at $1624.07/oz. Although we recognise that investor concern is slowly rising, we feel the market is still willing to give the US the benefit of the doubt for now. Nevertheless, as August 2 approaches, FX markets are likely to become increasingly volatile if no compromise is in sight. USDJPY and USDCHF in particular are likely to feel increasingly heavy, while risk pairs such as AUDUSD and NZDUSD may come under significant downward pressure – especially if equity markets weaken in tandem. US Treasury Secretary Geithner met with Fed Chairman Bernanke and New York Fed President Dudley on Friday to discuss the economic implications of a failure to raise the debt ceiling in a timely manner.
EUR
Moody’s cut Greece’s sovereign rating by three notches to Ca on Monday, taking it to one notch above the lowest possible rating. This is not yet a selective default, although the agency noted that under the terms announced on Thursday, “the probability of a distressed exchange, and hence a default, on Greek government bonds is virtually 100%.”
Bundesbank President Weidmann gave a balanced assessment of the decisions taken at Thursday’s EU summit, noting that “acute tensions in financial markets” might now be reduced. However, he also observed that “substantial additional risks were shifted to assisting countries and their taxpayers”, which “weakens the foundation for a currency union based on fiscal self-responsibility”.
On Friday there was further substantial tightening of Greek, Portuguese, and Irish sovereign bond spreads. However, Spanish and Italian 10y bond yields actually ended the day slightly wider, suggesting concern over contagion risk remains elevated. European politicians do not appear to be in any hurry to enact the proposals made on Thursday. Germany’s Chancellor Merkel suggested she would not attempt to win support from the German parliament for Thursday’s summit decisions until after the summer recess.
Fitch announced that Greece’s sovereign rating would be cut to ‘restricted default’, but implied that this would not happen until private sector participation levels were known. Furthermore, Fitch’s expectation is that this rating would only apply for “a few days”, and would then be raised to “single B” or “CCC” as soon as new bonds are issued to replace the old. We note that the ‘restricted default’ term used by Fitch is equivalent to the ‘selective default’ rating used by Moody’s and S&P.
Bank of Portugal Governor Costa ruled out the possibility of Portugal having its rating cut to selective default, dismissing the idea as “out of the question”.
Fitch also announced that proposals to extend the powers of the EFSF, announced at Thursday’s EU summit, would not imperil the EFSF’s triple-A rating given that it is backed by guarantees.
ECB President Trichet again laid out his vision for institutional and governance reform within the Eurozone. He said in the future “it should be possible to impose measures on a country that does not implement the agreed adjustments”. Looking even further ahead, he said that “a new type of confederation” could be created involving a “European finance ministry with its own responsibilities”. Trichet added that the euro is not in the midst of a “currency crisis” because it is stable and keeps its value extremely well.
The German Ifo business climate survey for July came in slightly weaker than expected at 112.9 (cons. 113.8). According to the report, conditions in Germany worsened, mainly on significantly weakening export expectations..
JPY
Finance Minister Noda said that the government “will take resolute actions when necessary” to help counter the yen’s strength. He added that he needs to watch FX moves closely, as was the case during the joint G7 intervention in March. This is arguably the strongest warning issued since then, and illustrates that intervention risk is now extremely high.
AUD
PPI for Q2 came in exactly in line with consensus at +0.8% q/q, and +3.4% y/y. As signalled in the recent RBA minutes, Wednesday’s CPI print will be a key driver of monetary policy. Our Australian economists maintain their above-consensus +0.9% q/q forecast, and stick to their view that the next hike is due in October.
RBA Assistant Governor Edey said that domestic Australian banks have limited exposure to the sovereign debt of countries regarded as most at risk..
CAD
June inflation was much weaker than expected, with the headline rate coming in at only +3.1% y/y (cons. 3.6%). The core figure also dropped to +1.3% y/y (prev. 1.9%), seriously dampening market expectations for an early hike from the Bank of Canada.
TECHNICAL OUTLOOK
EURUSD watch 1.4578 resistance.
EURUSD NEUTRAL A move above 1.4578 would trigger a bull trend, while support lies at 1.4134.
USDJPY BEARISH Initial support lies at 77.41, a move below which would open 76.25, a key low. Resistance is at 79.32.
GBPUSD BULLISH Clearance of 1.6366 would expose 1.6442. Near-term support lies at 1.6121.
USDCHF BEARISH Key support lies at 0.8033, a fall below which would open 0.8000, the psychological level. Resistance is at 0.8278.
AUDUSD BULLISH A move above 1.0889 would open the way towards 1.0953. Support is at 1.0694.
USDCAD BEARISH The pair has support at 0.9423 ahead of 0.9385. Resistance is at 0.9610.
EURCHF BEARISH Recovery found resistance at 1.1888. Focus is back on the downside with initial support at 1.1572 ahead of 1.1496.
EURGBP BEARISH Support is at 0.8757, a break of which would open 0.8705, a key low. Resistance holds at 0.8895.
EURJPY BEARISH While resistance at 113.66 holds, watch for a decline through 111.46 to expose 110.66.
SCHEDULE
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