Euro and traders of risk may be more skeptical than the European Union provided

30 June 2012 07: 14 GMT  Euro and Risk Traders May Prove More Skeptical than the EU Anticipated
Fundamental Forecast for the Euro: Bearish
EU Summit surprises with open bailout vow Questions build immediately to lasting influence of EU's programs EURUSD posts its biggest rally since Greek debt deal in October If it weren't for this past Friday's blockbuster rally, the euro's week would have been essentially wasted. EURUSD mounted its biggest rally since late October in a single move that was triggered by unexpected progress at yet another 'critical' European crisis discussion. Yet, despite the momentum on this swell and the confirmation from government bond yields and risk appetite general trends; There seems a larger call to fade this run than any other rescue/stimulus-driven move from European officials in the past. What's more, this is not just a building call amongst the speculative ranks. It is a warning that has been issued by respectable and often conservative economists and bank research teams. Does such a loud consensus guarantee the euro's reversal and extended collapse?
It is interesting to note that Friday's EURUSD rally (1.8 percent) was the largest since October 27 exactly. For reference, that previous rally was sparked by the Greek debt deal which arguably extinguished an immediate crisis fire; and yet the market still pulled an about-face and tumbled immediate 1500 pips in less than three months. That doesn't mean that the euro is destined for the same fate this go around, but the fundamental comparisons between the current situation and October are remarkable. And, if anything, they are worse now.
Reviewing the spark that ignited the roar of euro confidence this past week, we find there were very extraordinary policy concessions that were after the first day of the Summit... at least it seemed that way at first glance. The official statement from the group itself was convoluted and ambiguous - likely by design. Overlooked were the easily won European Investment Bank €10 billion funding increase and the €120 billion Growth Pact. The French, Italian and Spanish Prime Ministers were focused on the short-term threat of a building financial crisis and the risk it posed with spreading beyond Spain and deeper to the core. Running the negotiations into the early morning hours Friday, the results were a seeming defeat for fiscally-minded German and victory for the high-yield counterparts.
The critical highlights from the event included: Spain finding direct funding for its banking sector using EFSF funds without a seniority issue; agreement that a common, Euro-area banking supervisor would need to be created; clearance for the MSO to fund banks directly. and most ambitiously of all, approval for the MSO to buy government bonds to stabilize sovereign rates. That seems a serious escalation of the crisis fight, until we look at the details. The particulars of the Spanish bailout are still open to debate and funding comes after a Memorandum of Understanding is worked out. The bank overseer is due sometime before the end of the year and there are no details. Before the ESM program can directly fund banks, we need the bank supervisor. Further, with €100 billion already earmarked for Spain, the fund only has €400 billion left. Finally, we have the critical effort to cap sovereign yields that explicitly requires meeting certain conditions (which have not been explained) and it too requires a Memorandum of Understanding.
All the major points of progress in this Summit require additional agreements and are subject to conditionality that conservative Euro area members will certainly set high benchmarks on. A year ago, this would be a reality we priced in through the 'medium term' and name the markets to run through the good will the promises offered before they realized the lack of content. This time around though, we are dealing with a market full of skeptics that are more than aware of the global slowdown and now multi-source of financial instability.
Given the heavy voice of doubt at the economist-level usually reserved, speculators will likely be on edge heading into the new week. Should risk trends falter, the euro will easily cave to pessimism. However, there are a few things we need to keep a close eye on. Wednesday's US liquidity lull for the Independence Day holiday can change the dynamic of trends. More importantly, brings the ECB rate decision Thursday. A rate cut would lower its return potential and a lack of an LTRO program would leave the door open to volatility. A word to government bond purchases will be forefront in bulls' minds. And, then we always have risk appetite distraction in Friday's US NFPs. - JK

? Is the Market Skeptical of Spain’s Bailout?

Dollar Posts Impressive Recovery as European Rescue Hope Fades Euro: Is the Market Skeptical of Spain’s Bailout? British Pound Has yet to Reap the Full Repercussions of Posen’s Dovishness Australian Dollar Tumbles Under Risk, Chinese Data Fails to Impress Swiss Franc Find Little Relief from Euro Efforts, Market Focused on SNB Yen Gains Traction as Risk Reverses, New BoJ Nominees Stir Policy Forecasts Gold Makes No Serious Moves on Another Stimulus Influx, Affections Lay Elsewhere Dollar Posts Impressive Recovery as European Rescue Hope Fades
The fallout from Spain’s bailout announcement was clearly visible across the risk spectrum, and the dollarmade no effort to hide its connection to underlying investor sentiment or the euro’s trouble. Through the opening hours of trade Monday, the weight of the announcement that European authorities would rescue its most recently troubled member (more on that below) offered some relief panicked risk aversion position. That, however, didn’t last for very long. On a high profile bounce from the 10,150-level that technical traders would recognize, saw a sharp risk aversion drive that was mirrored in dramatic form with the S&P 500. That said, we should not take this sharp turn to be an indication of momentum behind risk trends. We have a Greek election and Fed rate decision due next week –items that can truly change sentiment.
Euro: Is the Market Skeptical of Spain’s Bailout?
Back in May of 2010, European policy officials had believed that a Greek bailout would prevent further crisis from spreading to the rest of the region. Fast forward to today, in the wake of the fourth country rescue, the market doesn’t even pause to establish the merits of the effort. It is difficult to believe that direct support for Spain’s banks can stabilize the country’s own financial system much less solve the entire region’s underlying troubles. As expected heading into the weekend, Euro Zone Finance Ministers approved a request from Spain to raise funds to recapitalize the banking system. The vow alone was significant enough to offer the euro and risk trends a bounce – but follow through is something completely separate.
Skepticism surrounding this particular effort has its roots in the market’s understanding that previous rescue efforts for Greece, Ireland and Portugal have all failed to stem the contagion. So, while officials win points for acting before the situation required a last minute solution to avoid catastrophe; this policy model does not spell recovery. Even short-term hope for stability is marred by the serious lack of details in this effort. The size, administration, timing and source of the funds are all still significant holes in the effort. The ‘up to €100 billion’ program will supposedly go directly to fund banks, but that doesn’t materially make this program more effective than previous ones. Furthermore, the size of the funding and who receives them won’t be decided until after the independent review of the country’s banking sector is completed – expected supposedly on June 21. Perhaps the most damning aspect in the whole situation though is whether the funds come from the EFSF (the temporary rescue fund) or the ESM (its permanent replacement starting next month). The latter would automatically subordinate any current Spanish bond holders whereby EU countries would receive funds first in the event of a default. Of course, we only need to remember Greece’s restructuring to see the EFSF isn’t exactly safe. Nevertheless, a market sensitive to these details will start to worry not only about Spain, but potential Italy as well.
With so many questions about Spain’s rescue still lingering, there is little room to find a sudden rush of optimism and euro buying interest. This is particularly true when we recall that there is a far more immediate and binary event ahead of us: the second Greek election this weekend. In the meantime, Greece is taking a necessary gamble with a €1.25 billion auction of six-month notes in the upcoming session.
British Pound Has yet to Reap the Full Repercussions of Posen’s Dovishness
Where the Bank of England gave us little guidance after its last rate decision, we can always count on the group’s most dovish member to tell us when conditions have taken a turn for the worse. It was unusual when MPC member Posen pulled back on its calls for further stimulus a few months ago. And, after the contraction in growth and repeated concerns of the Euro Zone’s crisis impact on the UK’s financial and economic health; the dovish draw was returning. Monday, the central banker returned to his true colors when he said now was the time for the BoE and other central banks to be buying private sector assets. In the upcoming session we have factory activity and GDP estimate numbers due.
Australian Dollar Tumbles Under Risk, Chinese Data Fails to Impress
There was a round of notable Chinese data hitting the wires over the weekend, but it did little to improve the recent shine on the Aussie dollar. In the wake of the currency’s recovery last week following strong growth, improved rate prospects and China’s rate cut; the high-yield currency didn’t hesitate in its response to the risk reversal from equities Monday. The Chinese data itself was something of a mixed bag with new loans for May beating expectations (793 billion yuan) and encouraging a brighter outlook for growth while retail sales and industrial production came in under forecasts. It’s worth noting that the 12-month rate forecast is still calling for around 100 bps worth of cuts. It’s smaller, but still cuts.
Swiss Franc Find Little Relief from Euro Efforts, Market Focused on SNB
An effort to stabilize – if not improve – Europe’s financial health should theoretically relieve pressure on the EURCHF cross. That is the theory anyways. Looking at the pair itself, there was barely a hiccup in price action to the news that Spain would receive a sizable bailout. This is yet a further reflection of the market’s skepticism in the commitment and capabilities of the rescue program for this important Euro-area member. Furthermore, franc traders are preoccupied with the lead up to the SNB rate decision. Meanwhile, we have 2012 SECO growth forecasts due.
Yen Gains Traction as Risk Reverses, New BoJ Nominees Stir Policy Forecasts
In a reversal for risk trends, there is little doubt as to what the yen crosses will do. The recent rebound in the high-yield pairs was always highly sensitive to correction as the speculative element that has carried capital markets higher has banked on stability – not true recovery. In other news, Noda’s office nominated two new bank economists to fill BoJ spots. They require Diet approval, but they both have supported stimulus.
Gold Makes No Serious Moves on Another Stimulus Influx, Affections Lay Elsewhere
As if we needed another fundamental layer of support for it, gold was offer yet another sign that the Spanish bailout was not well received. The precious metal usually takes off in the face of stimulus programs as it naturally devalues a currency. That said, the metal was carving a relatively restrained range through Monday – especially when we compare it to a competitive safe haven like EURUSD.
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ECONOMIC DATA
Next 24 Hours
Housing data cooled notably in April, though it did not reverse a steady trend of strengthening
Business sentiment could be marred by the slowing of China, EU troubles
French Non-Farm Payrolls (QoQ) (1Q F)
A final and lagging reading, this won’t distract from risk trends.
SECO 2012 Economic Forecasts (JUN)
Growth forecasts will be another piece of the speculative puzzle to the SNB
Industrial Production (MoM) (APR)
Factory output will be absorbed as another sign of Euro crisis transmission, the austerity/growth gauge and BoE stimulus potential
Industrial Production (YoY) (APR)
Manufacturing Production (MoM) (APR)
Manufacturing Production (YoY) (APR)
NFIB Small Business Optimism (MAY)
Second tier indicators for market impact but high level concerns for short-term volatility.
Import Price Index (MoM) (MAY)
Import Price Index (YoY) (MAY)
IBD/TIPP Economic Optimism (JUN)
NIESR Gross Domestic Product Estimate (MAY)
Indicator of future stimulus from the BOE.
Monthly Budget Statement (MAY)
Expected to reverse the first surplus reading since September 2008 in April.
Taken with tool orders, a good manufacturing / trade leading indicator.
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