Risk Back Off
The market was back in risk off mode overnight as the Fed’s failure to complement the PBOC’s interest rate cut with hints of more stimulus disappointed. It is clear that in the face of weakening growth expectations and Eurozone woes, the market needs more than just a shot in the arm, especially if the non-Eurozone economies are expected to compensate for a lack of action within Europe. Yesterday Bernanke did flag the risks and kept all policy options open – yet failed to offer any real hints of impending action at the FOMC meeting on June 19-20. To be sure, Bernanke highlighted the potential headwinds ahead that have prevented the Fed from taking any options off the table yet, warning that “the situation in Europe poses significant risks to the US financial system and economy” and the fiscal cliff would “pose a significant threat to the recovery”. However, Bernanke stopped short of suggesting that the Fed was prepared to act preemptively to avert a crisis, a somewhat less dovish posture relative to that of Vice Chair Yellen, who earlier noted “there are a number of significant downside risks to the economic outlook, and hence it may well be appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest”. Overnight Chicago Fed’s Evans reiterated that more policy accommodation was needed, but Dallas Fed’s Fisher said that the US is the world’s dominant reserve currency and there was no need for more accommodation. On balance though it appears the doves are being more vocal at this stage. Fitch also downgraded Spain to BBB (3-notches) and implicit in the downgrade were higher than expected recapitalisation needs for Spanish banks, which Fitch estimated to range from EUR60 bn (6% of GDP) to EUR100 bn. Fitch projected that gross general government debt would peak at 95% of GDP in 2015 assuming a EUR60 bn recapitalisation programme and a lingering recession through the remainder of 2012 and 2013 – concluding that Spain’s reduced financing flexibility has “increased the likelihood of external financial support”. The downgrade was not totally unexpected in a market where risk sentiment has improved materially and investors still seem to be searching for positive headlines. Ahead today, Canadian the labour market report is the key release. The US trade balance is out.
Click here to read the full report: UBS Morning Adviser Europe
UBS Investment Bank