Draghi Signals More Easing
Risk appetite continued to wane overnight after revelations on Friday that the Spanish region of Valencia is set to call on the central government’s assistance to help roll its maturing debt. The Spanish government has already set up a EUR18 bn emergency loan fund for exactly this purpose, but Valencia’s announcement could put additional stress on the central government which is already suffering from its own funding problems. The downbeat mood overnight was transmitted to FX markets through Asian equities which followed the S&P500 lower. With equities finally reacting to European developments, AUDUSD naturally 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. With Spanish 10y yields closing well above 7%, risks that Spain may request a fullyfledged EU/IMF bail-out are clearly rising unless the ECB directly intervenes in the bond market via its long-dormant SMP program. Meanwhile, negative 2y yields in the core sovereign bond markets show that capital flight out of the Eurozone’s periphery is worsening. Euro remains under pressure – against the dollar and on all the major crosses except EURCHF. We expect this trend to continue and note the next big technical support level is at 1.187 in EURUSD.
Click here to read the full report: UBS Morning Adviser Europe
UBS Investment Bank