Global Markets Applaud EU Breakthrough

In an effort to break the negative feedback loop between banks and European nations, EU leaders have agreed to allow struggling banks to recapitalize using the regions rescue funds the European Financial Stability Fund and the European Stability Mechanism. Importantly, leaders also agreed to allow the regions rescue fund to buy distressed government debt to reduce borrowing costs of countries at risk of being shut out of bond markets. Although it may be unwise at this early stage to regard this as a watershed moment in Europe’s plight to regain economic composure, it represents a significant milestone for countries such as Spain who earlier last week formally requested financial aid in order to recapitalize their struggling banking system. In essence, this latest effort promotes segregation between the banking sector and governments who would generally suffer the negative repercussions through higher borrowing costs. Under the plan, leaders have agreed to create a supervisory body in order to govern the disbursement of capital.
 
Markets responded to the news in kind with a notable leg higher seen through the latter half of domestic trade on Friday and gained momentum through to European trade with the DAX and CAC finishing a remarkable 4.33 and 4.75 percent higher. Likewise U.S markets recorded solid gains with the DOW and S&P rising 2.2 and 2.5 percent respectively. Given the dour market expectations leading up to the summit, previous short positioning amplified gains across the risk spectrum with those short and caught effectively squeezed out the market. After testing the $US1.24-figure later in the week, the Euro’s fortunes quickly changed with the EURUSD pair rising to highs just shy of $1.27-figure to finish the week near 1.0 percent higher against the greenback. Commodity bloc currencies also recorded convincing gains with the Aussie dollar making clean upside break to highs of 102.57 US cents. The USD index which measures the value of the dollar against six major counterparts finished the week 0.76 percent lower after being up as much as 0.7 percent prior to the EU announcement.
 
Judging by market response investors are clearly inspired by the latest European effort, however it remains to be seen if this represents the key inflection point we’ve been waiting for or simply a short-term sugar-high before the negativity sets in once again.  Nevertheless, we’ve seen significant improvement from southern European debt markets with Spanish 10yr bond yields dropping below the 6.5 percent mark – an encouraging factor considering earlier in the week yields touched euro-era highs above the 7 percent region.  In short, It appears European leaders have narrowly avoided a dooms day scenario for the umpteenth time. 
 
RBA to hold a steady course after a “finely balanced” 25 bps cut in June
 
After a fairly light week on the macro front, the local week ahead will see the focus turn to a number of key events with the RBA’s policy meeting on Tuesday the headliner. The release of June’s policy meeting minutes showed Stevens and Co remain cautious given the negative shock-waves resonating from abroad, in particular Europe. Nevertheless, after a 50bps cut to the official cash rate in May, the minutes showed the board’s decision to slice a further 25bps was “finely balanced” given little in the way of new information suggesting significant weakening locally, while also taking into account the need assess previous policy adjustments. This suggests the RBA will hold a steady course this Tuesday as they understand the effects of previous easing, in addition to tentative signs of stability from the Euro region. Also on the local docket this week will see the TD securities inflation gauge act as a timely measure ahead of the RBA decision on Tuesday. Later in the week will see the release of retail sales and trade balance data for May. Also in focus will be the HSBC Manufacturing PMI (Monday) and Services PMI (Tuesday).
 
Euro to take direction from ECB as case for rate cut gains momentum
 
This week from the Euro-Zone will see the European Central Bank rates decision take centre stage. Despite some of the more vocal directives such as last week’s EU summit still likely to govern sentiment, the case for an ECB rate cut has quietly gained momentum and will be a key theme this week.  If ECB president Mario Draghi was holding back on policy easing to keep the pressure on political leaders, this week’s meeting may see the ECB take advantage of what appears to be some progress on the political front with Draghi noting the latest EU initiative as a positive result. Subdued inflation from the Euro-Zones flagship economy Germany has also provided further weight to the argument of a near-term rate cut with last week’s headline CPI data showing annual growth of 1.7 percent. However, the ECB may still conclude there is still not enough evidence to suggest inflation is easing at a pace worth of policy easing with Friday’s Euro-Zone CPI estimate showing annual growth of 2.4 percent in June.  Final revision to both German and Euro-Zone consumer prices will be release in mid July. Across the Chanel, the Bank of England may now have the ample breathing space to step-up easing measures with another £50 billion expected to be added to their quantitative easing tally at Thursdays policy meeting.
 
U.S dollar at the mercy of QE expectations ahead of Friday jobs report
 
Among the usual risk-orientated themes guiding the U.S dollar, the week ahead will see market participants look to the June jobs report as a barometer of how the U.S economy is travelling. The U.S economy is expected to have created 90,000 jobs in June from a previous 69,000, with the official unemployment rate to remain unchanged at 8.2 percent. A slew of jobs-related precursors may sway market expectations in the lead up with ADP employment change, Challenger job cuts and weekly jobless claims due for release ahead of Friday’s non-farm payrolls. Earlier in the week the health of U.S manufacturing will be in the spotlight with ISM Manufacturing Index on Monday and Factory orders on Tuesday. The USD index which measures the value of the dollar against six major counterparts finished the week 0.76 percent lower, after being up over 0.7 percent higher prior to the EU Summit announcement.