Germany Downgraded
The euro lacked clear direction, as investors tried to weigh the possible outcomes from the EU Summit. The initial focus was on the report prepared by European Council President Herman Van Rompuy – in collaboration with his counterparts in the European Commission, the ECB and the Eurogroup – aimed at “developing a vision for the EMU”. There were no surprises in the carefully-worded report that highlighted the importance of a financial and a fiscal union with “greater pooling of decision making on budgets, commensurate with the pooling of risks”. However, as expected, details on how these plans could be implemented are conspicuously absent. EU officials stated that further work “to develop a specific and time-bound road map” will come in a report in December, with an interim report due in October. So for this week, we would expect an agreement only on a broad framework based on the Commission’s proposals, with details hopefully emerging by the next Summit in the autumn. German Chancellor Angela Merkel already expressed her reservations to the proposals, reportedly saying that they have the wrong balance of shared liability and control. Sentiment was certainly not helped by Egan-Jones, which downgraded Germany’s sovereign rating to A+ from AA- (negative outlook) on Tuesday, widening the gap with the major ratings agencies. Though the EURUSD reaction was rather muted, the downgrade will likely magnify fears of further ratings actions in the Eurozone and reinforce Germany’s opposition to any notion of shared liability. In this context, the difficulties involved in finding common ground acceptable to both the creditor and debtor nations of the Eurozone are aplenty, reaffirming the prospect of a lengthy and arduous period of negotiations that will likely keep investors on edge. Against this backdrop, we stick to our 3m and 12m EURUSD forecasts of 1.20 and 1.15, respectively. Elsewhere, in the US, home prices as measured by the S&P/CS index jumped 0.7% m/m in April, while the consumer confidence index slipped to 62.0 in June from 64.4 in May. The Richmond Fed manufacturing survey was a bit weaker than expected in June, falling to -3 from +4 in May. However, our US economists note that the details were less negative, with the employment component remaining squarely in positive territory. The focus now shifts to the Merkel-Hollande ‘working dinner’ in Paris later today.
Click here to read the full report: UBS Morning Adviser Asia
UBS Investment Bank