Euro Slipping Already
Risk assets – including the euro – had an impressive rally on Friday, and the question now is to what extent those gains can be sustained, and for how long. The euro has already seen some modest slippage overnight but with a July 4 holiday on Wednesday, an ECB policy decision due on Thursday, non-farm payrolls on Friday, and a meeting of Eurozone finance ministers the week after, the scope for a sharp correction lower seems quite limited. However, investors have now had a weekend to digest the outcome of Friday’s EU Summit and we would not be surprised to see some gentle euro downside as a result. Some progress was made on three separate fronts but by now the limited nature of the policy initiatives should be well known. Yes, there is a clear intention to use the Eurozone’s bailout facilities to buy sovereign bonds in the secondary market, but any imminent purchases seem unlikely until outstanding issues around conditionality are fully ironed out. Even then, such a program would have limited firepower at its disposal. Second, although European loans for Spain’s banking sector bail-out will no longer be explicitly senior to debts owed to private sector bondholders there is no explicit indication that they will rank pari passu. Rather than being reassured then, bondholders merely now find themselves in an indeterminate state. Third, it should now be clear that using European funds to directly recapitalize banks is a long term ambition – something Germany’s Chancellor Merkel has already suggested may take “perhaps a year”. So while Friday’s developments have bought some time for the euro, the bearish case for the currency remains very much intact, and we reiterate our 1m and 3m targets for EURUSD at 1.24 and 1.20 respectively. Elsewhere, China’s manufacturing PMI came in slightly above consensus over the weekend, dropping to 50.2 in June from 50.4 in May. Attention now turns to Thursday’s ECB policy decision where a majority of economists expect a 25bp cut to the refi rate - even though only 8bp of easing is priced in. We would expect to see further downward pressure on the euro if a refi rate cut is forthcoming provided the deposit rate is also cut in tandem.
Click here to read the full report: UBS Morning Adviser Europe
UBS Investment Bank