While Germany has softened its stance on the debt swap issue, overall risk appetite remains dependent on developments on Greece.
FOMC this week likely to use “extended period” language of both rates and balance sheet.
Likely diverging RBA, BoE minutes suggest further downside for GBPAUD.
While Friday undeniably saw some positive developments ahead of a critical week for Greece, comments after yesterday evening’s Eurogroup meeting suggest that the process is likely to drag out for a while yet. Germany softened its stance on the debt-swap issue, with Chancellor Merkel saying that the 2009 Vienna Initiative is a good foundation for a deal and that any contribution from the private sector must be voluntary. In addition, the EU and IMF agreed to disburse EUR 12bn to Greece even without full agreement on a new EUR 120bn bail-out. However the disbursement clearly has strings attached, even if there was no agreement last night on what exactly those strings might be. Belgian FinMin Reynders said that the decision on the next tranche of aid for Greece will be taken in early July, and will be “based on the Greek parliament’s decision.” The Eurogroup statement said that “national unity is a prerequisite for success” of any assistance package. Thus, rather than whether the EcoFin, the ECB and the IMF can come to an agreement, the key to a deal at this stage looks to be Greek domestic politics, and whether broader support for a longer-term aid package can be assembled. The first hurdle is the vote of confidence in the government called by the Greek PM; the three-day debate in parliament will culminate in the vote scheduled for midnight tomorrow. The second will be next week when the Greek parliament votes on the budget – including further austerity measures. In the meantime, the EUR will remain dependent on Greece-related headlines. A sharper deterioration in the newsflow could see EURCHF extend the move below the 1.1950 record low.
The main US event this week will be the FOMC meeting. Persistent data weakness out of the US will likely strengthen the FOMC’s dovish tone. The FOMC is expected to firm up its language on keeping rates low for an “extended period” and apply this language to the Fed balance sheet as well. Such dovish Fed language could prove negative for USD, keeping rates below 3% and potentially bringing USDJPY below the key Y80.00 level. Indeed, with risk unlikely to rebound significantly, yen crosses are at risk of a more significant move lower for the week.
This week should see diverging central bank minutes from the UK and Australia. The RBA minutes come at an interesting time: despite recent hawkish comments from RBA’s Stevens, markets have priced out any chance of another rate hike this year. A meaningful AUD rally likely remains contingent on the overall risk environment and what happens in Greece, but the minutes may provide some support nonetheless. In contrast, the BoE minutes this week will likely indicate that the BoE will keep rates on hold for a long time. The stream of economic news out of the UK has been appalling. While headline inflation is rising, weak growth indicates that the cost of hiking rates is high and will stay elevated. With wages subdued, the BoE is likely to remain fairly confident that inflation will decline. We expect no rate hikes this year or 2012. Thus, with a dovish BoE, we could see GBPUSD break below 1.60. In addition, an improvement in the overall risk environment can see GBPAUD back towards the lows of 1.5042.
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