Euro Still Under Pressure
The euro remained under pressure in the European session, driven primarily by a further sell off in periphery fixed income space. Italian 10y yields pushed above 6% catching up to Spanish 10y which are comfortably above 7%. These moves sparked a move lower in EURUSD and EURJPY along with wider risk appetite as European equity markets caught up. At the time of writing, we are still awaiting the details from the conference call between Eurozone finance ministers which started at 10.00 GMT – ostensibly to sign off on the terms of Spain’s banking sector bailout. Details on the approximate size of the loan and time scales involved have already been discussed publicly, and the first tranche is due to be released around the end of July. Although the finalization of the agreement will mark an important step towards addressing the capital adequacy of the Spanish banking system, the euro could still weaken if ratings agencies express misgivings on the implications for sovereign credit worthiness. 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. Yesterday’s auction of Spanish debt saw lukewarm demand, although euro bulls were at least able to breathe a sigh of relief on the approval of the Spanish bailout plan in the Lower House of Germany’s parliament by a comfortable margin – 473 votes in favour, versus 97 votes against and 13 abstentions – well beyond the simple majority that Merkel needed. Fitch also affirmed Italy’s ‘A-’ sovereign rating (negative outlook), given the agency’s approach of looking “beyond current economic and financial conditions and taking into account recent and prospective structural reforms that would enhance the growth potential of the economy as well as its assessment that debt stabilisation and reduction is within reach”. Nonetheless, risks clearly remain. Indeed, we believe Spain will ultimately have to request a full-fledged Troika programme and that the ESM/EFSF and/or ECB will have to intervene.
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UBS Investment Bank