Weak Spanish Bond Auction
The euro continued to cede ground overnight but rather than US policy expectations as the key driver, Eurozone issues are playing a greater role and the newsflow out of Spain is still worrying. A bond auction was poorly received and the Prime Minister warned that the country’s situation is of ‘extreme difficulty’. Our economists note that at this point, taking into account the details of the budget already released, the decisions look credible but some areas still look optimistic, especially on the matter of local authority debt. The banking sector’s issues still linger behind the scenes and this is starting to be reflected in Spanish yields. However, the lack of growth incentives on a Eurozone-wide level is still the biggest concern for the Eurozone in general and the ECB may be challenged to provide additional stimulus to alleviate the strains from austerity measures. However, recent rhetoric suggests a slightly greater focus on inflationary pressures in the pipeline, and investors will be keen to ask President Draghi whether the ECB is in a position to provide more liquidity via the SMP or LTRO in the current environment. Relative to the Fed however, the verdict is clear on where the ECB stands and the market will expect the 2014 normalisation guidance for the FOMC to be revised. However, we acknowledge that for the Fed, material movements are needed both on growth and inflation to ultimately achieve revision in their current policy communication. The Fed’s staff forecasts also pointed to better GDP figures and higher inflation, and trend growth was downgraded. A stronger-than-expected payrolls print would set the stage for a robust Q2 for both the dollar and risk appetite. The market will also need to acknowledge the difference between pricing in normalization and pricing out stimulus, as the reaction function in currencies to these two policy stances are different and the US economy will almost certainly still stand amidst different points in the cycle. Nonetheless, dollar growth bulls should be wary of rapid deterioration in the Eurozone’s sovereign state as this has been cited as one of the key risks for the US economy and could yet cause the Fed to rapidly adjust its positioning. The FOMC’s policy shifts are largely based on the assumption that exogenous shocks (either from oil or Europe) will be transitory at this stage, but they are keen to avoid a repeat of 2011 which could set back normalization by several quarters or more. Ahead today, the ECB post-decision press conference is due, and the ADP report and non-manufacturing ISM figures are out in the US. EURUSD traded in a range of 1.3156-1.3237 overnight and USDJPY 82.10-82.93.
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UBS Investment Bank