Sentiment Steadies, For Now
FX investor sentiment stabilized overnight despite weaker Asian equities and the S&P500 closing down 1.26%. Where we go from here will depend largely on how Eurozone bond markets perform from the open today. Monday’s euro selloff was driven by the Spanish sovereign bond market which ultimately reacted negatively to the weekend announcement that Europe is prepared to contribute up to EUR 100 bn to help recapitalize the Spanish banking system. Italian bonds also came under significant selling pressure with the 10y yield rising by 26bp to close above 6.0% the highest level this year. The sell-off seems to have been provoked by concern that the ESM’s preferred creditor status could trigger a CDS event if this vehicle is used to fund the bailout. Investors however took little consolation from newswire reports citing unnamed EU sources that funds could be channeled to Spain through the EFSF to avoid this seniority problem. More significantly, the International Swaps and Derivatives Association (ISDA) also announced that the rescue proposal is not likely to trigger a credit event through subordination – but this news only emerged after bond markets had closed for the day. Ratings agency reaction was somewhat positive too – S&P announced that Spain’s sovereign rating was unaffected by the weekend announcement and that, even if the EUR 100 bn were to be fully drawn, this would only take central government debt to over 80% of GDP. So we do see some scope for sentiment to continue to stabilize in the very near term, but given Greece’s second general election is only days away, we would fade any respite for risk currencies and would look to add to USD and JPY longs. Elsewhere, sterling fell after the Bank of England policymaker Posen again conceded that he was “too optimistic” about the economy when he dropped his push for more stimulus in April. He suggested that further asset purchases from the central bank could improve the economic situation at this point. We see further downside risks for GBPUSD in particular as the Fed isn’t set to ease monetary policy for now, but the risks remain that the BoE’s MPC votes to launch a third round of quantitative easing in the UK this summer.
Click here to read the full report: UBS Morning Adviser Europe
UBS Investment Bank