Eurozone Core Under Scrutiny
The euro opened Tuesday trading on a very weak footing as Moody’s revised ratings outlooks for Germany, Holland and Luxembourg late during the US session to negative. Finland’s ratings were affirmed at AAA and the country did not suffer an outlook revision. Germany, having just regained ‘Outlook Stable’ with all three major ratings agencies just over six months ago, has lost this status again. Moody’s cited the risk of burdens falling on the most highly-rated states in the event of joint liability being assumed, and in doing so the pool of benchmark AAA assets (outlook stable and not on credit watch negative) has shrunk by more than half. The euro dropped on the back of the news but weak performance throughout Monday on the back of a return in sovereign fears had probably mitigated the impact of the ratings decision. Besides, it is hard to see Eurozone-based investors with a euro mandate pulling funds out of core Europe en masse. However, for non-Eurozone investors this only adds to the pressure to reduce exposure, especially with further benchmark rate cuts being priced in and the prospect of a proliferation in negative yields in countries with limited credit risk seriously affecting investor interest. Commentary throughout Monday from the Eurozone also lacked a sense of conviction for crisis resolution in the coming months, though in the short term the focus is back on Greece as the troika resumes its mission. Away from Europe, growth concerns continue to dominate proceedings. Markets are watching the Chinese authorities to stabilize sentiment with stimulus plans, and some initial results may be showing as the Flash Manufacturing PMI rebounded to 49.5 as output jumped. We have not witnessed serious deleveraging out of emerging markets as a source of risk aversion, but the lack of efficacy in policy action does not seem limited to G10 and further deterioration in growth expectations could have major implications for global flow patterns. In light of current Eurozone risks, we have moved our EUR exchange rate targets lower across the board. Our 1m EURUSD forecast is now at 1.20, and we still target a move to 1.15 by year end. Despite global growth risks, we shift our AUDUSD view higher to 1.00 in 1m and 0.97 in 3m. Firm data, sovereign buying and AAA-demand should keep the structural bid in place. Fed Chairman Bernanke speaks today at 12:45 GMT, while advance July PMI figures are due in Germany and across Europe.
Click here to read the full report: UBS Morning Adviser Europe
UBS Investment Bank