EU Agrees To Allows Rescue Funds To Capitalize Spanish Banks Directly

• Rompuy announced that EU has agreed to drop preferred creditor status on Spanish bank rescue loans and to allow rescue funds to capitalize banks directly.
• Monti refuses to sign growth package until Germany agrees to support short-term measures.
• Risk sentiment has improved and EUR has strengthened after the Rompuy news.

EU President Rompuy said that EU leaders have agreed to drop the requirement that governments get preferred creditor status on loans given to Spain’s banks. Banks can also be capitalized directly by the EU’s rescue funds without going through governments. 

According to media sources, Italian prime minister Monti is holding up the EUR 120bn growth package already agreed upon last week, refusing to sign the final document until Germany agrees to support short-term measures to provide relief from the debt crisis. Senior officials from the 17 eurozone finance ministries met on the sidelines of the EU summit to discuss emergency plans for Italy and Spain, focusing on how to use the rescue funds (EFSF/ESM) for short-term fire-fighting. Different media sources suggest that the preferred tool is primary market purchases of Spanish and Italian bonds funded through the EFSF/ESM. This is already an existing option for the rescue funds but such assistance is prescribed to go hand in hand with an adjustment programme. However, we will have to wait for today’s press conference to get more concrete information on the final outcomes of the EU summit.  

The US supreme court concluded Thursday that Obama’s health care reform, which requires citizens to carry insurance or pay a penalty, is valid under Congress’ constitutional authority to lay and collect taxes to the general welfare of the United States. The ruling leaves health care as one of the hot topics for this fall’s presidential election campaign as Republican presidential candidate Romney has stated that if elected, he will repeal the law first thing. 

It was a volatile day in US stock markets. Early losses reversed later in the trading session on hopes that the EU summit would provide short-term measures dampening the current market stress. The S&P500 ended the day down 0.2%. In Asian trading markets are taking the news of the EU dropping the senior seniority on bank rescue loans well and stocks are generally higher. 

In European bond markets the 10-year Spanish and Italian spreads towards Germany widened modestly yesterday leaving the spread 40 to 60bp wider so far this week. In the US, Treasurys had a good day but reversed some of the gains late in the session as stock markets rebounded. The 10-year yield ended the day 5bp lower.  

In forex markets EUR rebounded strongly after the Rompuy news and is now trading just below 1.26 against USD. Raw materials advanced and oil prices are up 2% this morning. 

Global Daily

The progress at the EU summit will also be the centre of attention today. Today’s meeting will start at 10:00 CET and there are two press conferences scheduled. The first will be on the outcome of the EU27 meeting. After this a euro summit will commence, so from a market perspective the afternoon press conference will be the most interesting. We also have a couple of interesting releases in the European session. We expect euro area M3 growth to drop further to 2.1% y/y, while we expect CPI for June to be unchanged at 2.4%. Inflation expectations are coming down in the euro area on the back of decreasing oil prices and should pave the way for an ECB cut at the meeting in the coming week. In the US we are due to receive data for core PCE. As it is the Fed’s preferred inflation measure, we will look to this to see whether inflation continues to ease. We expect to see a reading of 0.1% m/m and 1.8% y/y, well within the Fed’s confidence band, allowing the Fed to focus on the second part of its mandate – employment. 

Fixed income markets: Even though policy makers may be edging towards the right solution, large political hurdles remain regarding implementation. The situation is still uncertain and fundamentals continue to deteriorate rapidly as the macro picture worsens and yields are high. Overall we see value in being overweight core market duration following the sell-off in most of June, where for instance the German Bund yield moved some 30bp higher. Lately the ECB has signalled a rate cut in the refi rate and possibly also in the deposit rate at the July meeting. Currently, it is roughly priced into the markets that the deposit rate will be lowered by 10bp to 0.15% and the refi rate by 25bp to 0.75%. 

FX markets: EUR rebounded strongly on the announcement that seniority is renounced on Spain loans and that EU bailout fund can be used more flexibly. EUR/USD jumped more than one big figure to trade as high as 1.2628 before edging slightly lower again to trade around 1.2575. The strong reaction shows just how low expectations were going into the summit and just how long dollar investors were. We will have to see if more comes out of the meeting today but so far it has certainly been a much more market positive outcome than most would have hoped for. Previous policy responses have tended to deliver only short-lasting rallies and with the ECB set to cut rates next week it should be difficult for EUR/USD to edge significantly higher. That said, this should certainly act as an important backstopper for a further near-term EUR sell-off.

Scandi Daily

Household lending for May will be released today. The year-on-year rate has gradually declined by about 0.1 percentage point per month of late and that trend is expected to continue. In April lending was up by 4.8% y/y basically reflecting base effects. 

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