Pressure in Europe Continues, Underpins Dollar and Yen

The US dollar and Japanese yen continue to be the biggest beneficiaries of the heightened tensions emanating from Europe.  Many see the seeming inability of the Greece to form a new government as increasing risk that it leaves monetary union.  With some a large asset manager and an investment bank claiming the Fed is going to resume its asset purchases next month one may be surprised that gold is off more than 1% and near the lows for the year.  

The policy market web site, www.intrade.com, currently places the odds of a country leaving the euro zone at 31.5% by the end of this year; 49% by the end of next year, and 62% by the end of 2014.  Yes these "contracts" are thinly traded compared to the turnover in the capital markets, but does offer a "second opinion" to claims in the press that the odds are seen at 90%. 


Many do not seem clear on the process.  If Syriza fails to cobble together a government after at most two more days, and this seems to be the case, the mandate goes back to PASOK, the Socialists.  If they fail after three days, the mandate goes back to the President who tries to broker a national unity government.   Only if that too fails does the constitution call for new elections.  Moreover, as we have seen in other parliamentary democracies, a minority government, that depends on support from a non-coalition partner is possible as well.  True it is not ideal, but it seems to beat some of the alternatives.

 As noted yesterday, it is not just Greece that is in the cross-hairs, but Spain as well.  The 10-year yield is back knocking at the 6% level.  Spanish shares are being crushed, off more than 2% near midday, with financials off closer to 3.5%.  An injection of funds into Bankia is expected before the weekend.  Note too that the CDS prices are up across the board in Europe and pressure is also evident in France.


Something that is not likely to be on your data calendar for Friday May 11 could very well prove to be the most important development in what is already an important week, given the election results in France, Greece, Germany and Italy. The EU Commission will provide new economic forecasts. After the recent string of data there can be little doubt that growth forecasts get cut and sharply so for several countries.

This is important in its own right as well as an indication of what to expected when the ECB announces its new forecasts early next month as Draghi confirmed at his recent press conference. There is another reason why the EU Commission forecasts are important. They may offer Ollie Rehn, the top EU economics official, an opportunity to draw on a clause in the fiscal agreement that will allow him to recommend loosening of the strict budget targets.

Several countries may be given extra year to reach their deficit targets. The clause allows for a year delay if after implementing austerity and reforms, a country his hit by adverse economic conditions. Arguably, Spain, Portugal and The Netherlands can qualify for such considerations. Given the recent change in tone, as illustrated by talk of a growth or investment pact, by officials including Rehn and Draghi, the possibility of this seems greater than many appreciate and would help buy time.

In contrast to the deepening downturn in Europe, Germany has reported  a series of data this week that has boosted sentiment about the world's fourth largest economy despite the poorer PMI data.  Monday it was industrial order data that offered the positive surprise.  Tuesday it was industrial production that was stronger than expected.   Today it is the trade balance that came in better than expected (13.7 bln euro rather than 13.5 bln).  It was flattered by the third consecutive monthly increase in exports.  

Separately, the shine is coming off sterling, which has been a market darling in recent weeks.  However, a string of soft economic data, including the same-store BRC sales figures (-3.3% year-over-year, which is the largest decline since last March), has spurred more talk that the BOE may decide to extend its asset purchases when the MPC's two day meeting concludes tomorrow. We remain skeptical, given the stubbornness of inflation and the less dovish minutes from last month's meeting.   A Bloomberg poll found 43 of 51 agree with this call.  The others look for an increase of GBP25 bln.

Lastly, note that Poland surprised the market with a 25 bp rate hike to 4.75%.  While the central bank had warned that a hike was possible, most, like ourselves, expected the hike next month.  As one would expect the zloty rallied on the news.  The central bank was responding to rising price pressures and the relative resilience of the Polish economy in the face of developments in the west.  Note that Indonesian and Korean central banks meet tomorrow and no change in rates is expected; nor from Malaysia that meets on Friday.