Risk Retreats Ahead of EU Summit

Risk appetite retreats mildly as the week starts in response to Fitch's downgrade of some Eurozone countries and as traders await the first EU summit in 2012 in Brussels. EU leaders are expected to sign off the permanent bailout fund, the European Stability Mechanism or ESM, today. The EUR 500b permanent will become operational in July, a year ahead of originally planned, replacing the temporary European Financial Stability Facility or EFSF. European leaders are also expected to discuss and possibly agree on the terms of the so called fiscal compact, which would tightening budget rules. The principles of the fiscal compact were agreed back in December but UK refused to participate. The current unused funds from EUR's 2007-2013 budget, at around EUR 20b, would also be redirected to revive the job markets.

There were news headlines stating that an agreement between Greece and its private sector bondholders (PSI) was close to resolution. It's reported that bondholders agreed to a deal that includes a coupon considerably lower than 4%. It's expected that an agreement will be finalized by this week. Meanwhile, the ECB reiterated that it won't be participating in Greek bond haircuts as "PSI stands for private sector involvement, ECB is not private'. On the other hand, the Financial Times reported that Germany suggested that a budget commissioner should be appointed to manage key budget decisions in Greece. The appointee will be responsible for "all major blocks of expenditure' and would have the power to "veto decisions not in line with the budgetary targets set by the Troika'. The reported indicated that the proposal might be set as a condition for a further EUR 130B bailout for Greece.3

Last Friday, Fitch lowered the sovereign credit ratings of Italy, Spain, Belgium, Slovenia and Cyprus. Italy's credit rating was reduced by two notches to A- from A+ while that of Spain was lowered to A from AA-. Ireland's rating of BBB-plus was affirmed. According to the rating agency, the "rating actions balance the marked deterioration in the economic outlook with both the substantive policy initiatives at the national level to address macro-financial and fiscal imbalances, and the initial success of the ECB's three-year Long-Term Refinancing Operation in easing near-term sovereign and bank funding pressures'.

Italy's bond auction today will be a test on market sentiments after Fitch's downgrade. Italy plans to sell as much as EUR 6b of 5 and 10 year bonds with securities due in April 2016 and March 2012. In addition, Belgium will sell EUR EUR 1.8b of 105-day bills and EUR 1.2b of 168-day debt tomorrow. Germany will sell EUR 5b of 10 year bonds on Wednesday. France will auction October EUR 8.3b of bills today and October 2018, October 2020, and April 2022 debt on Thursday. Spain will sell as much as EUR 4b of July 2015, October 2016 and January 2017 bonds on Thursday.

It's confirmed that RBNZ Governor Alan Bollard will step down after current term ends on September 25.

On the data front, German CPI, Eurozone confidence indicators, US personal income and spending will be released today.