Spanish Bonds Drive Markets
Euro weakness continued on Monday with Spanish yields rising further across the curve. 10y yields rose around 20bp, putting further downward pressure on the euro. UK, US and German yields all declined with UK 10y bonds setting record highs. The combination of negative yields across the front-end of core sovereign curves and persistent selling of Spanish paper is likely to keep the euro under pressure in our view. Risks that Spain may request a fully-fledged EU/IMF bail-out are clearly rising unless the ECB directly intervenes in the bond market via its long-dormant SMP FinMin Azumi maintained the same rhetoric of acting in case of excessive volatility in FX and against speculative moves, but added that the EURJPY move was driven by Eurozone problems. We see this as taking the ‘intervention premium’ which floors USDJPY away from EURJPY, with more reasons to sell the cross. Other asset classes were also following the sovereign fixed income markets, equity markets in Europe were trading in the red, though risk appetite did improve later in the session, with the euro reversing some of the overnight move. AUDUSD earlier found itself under some selling pressure until a slightly stronger than expected Australian PPI report brought some temporary respite. Further bad news emerged over the weekend though with the Spanish press claiming that at least one other Spanish region may follow in Valencia’s footsteps. Germany’s Vice-Chancellor also allowed the question of a possible Greek euro exit to resurface, noting that such a scenario had “lost” its fear factor. Most importantly, in a weekend interview in Le Monde, ECB President Draghi said that inflationary pressures are falling faster than was expected (even as recently as the last ECB board meeting). We see this as a clear signal that another rate cut is on the cards, and the comments support the view of our European economists who think we could see another cut to the refi rate as early as September. There were no US data releases on Friday which allowed the focus to fall all the more intensely on Spain. It didn’t help that Egan Jones cut Spain’s sovereign rating to CC+ from CCC+. We note that Moody’s has already placed Spain on review for a possible downgrade and that the sovereign is only a single notch away from junk status.
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