Risk Sentiments Boosted by EU Summit, Dollar And Yen Selloff To Continue

Expectations on last week's EU summit was pretty low but the responses were overwhelmingly positive. Risk markets were given a strong boost where DOW jumped from an intraweek low of 12450 to close at 12880. European equities were also strong with FTSE jumped from intraweek low of 5435 to close at 5571, while DAX also rebound from intraweek low of 6096.9 to close at 6416. Commodity markets were also strong with CRB index rebounded to close at 284.19, after dipping to 266.78. Dollar index, on the other hand, dived to as low as 81.43 before closing at 81.62, comparing to intraweek high of 82.88. The strong momentum is risk markets suggests that more rally lies ahead in near term and we'd now possibly see DOW revisiting this year's high in Q3. Based on that development, dollar and yen would likely remain pressured.

Probably due to the lack of expectations over the EU summit, the measures agreed by the 17-nation leaders surprisingly lifted market sentiment. The European Commission proposed to create a single supervisory mechanism with the ECB involved, allow the Spanish banking system to be financed through the EFSF for the moment and will later be replaced by the ESM without application of the seniority status and use the existing EFSF/ESM instruments 'stabilize markets for Member States'. EU leaders agreed on a growth pact worth of 120B euro, including 10B euro capital boost for the European Investment Bank (EIB). Rompuy stated that the growth pact 'is a sign of our unrelenting commitment' and 'it brings together all concrete measures that we will swiftly take'. Concerning the 100B euro bailout program for Spain, the leaders concluded that financial assistance will be “provided by the EFSF until the ESM becomes available and that it will then be transferred to the ESM'. More importantly there will be no party gaining seniority status, indicating the same status enjoyed by the fund and private investors. More in Euro Highest In A Week After The First Day Of EU Summit.

The development of EU summit overshadowed other negative developments in the Eurozone. Shortly after Spain's formal request for bailing out its banking sector, Moody's reduced long-term debt and deposit ratings for 28 Spanish banks and two issuer ratings. That include a cut to Banco Santander's long-term rating to Baa2 from A3 and Banco Bilbao Vizcaya Argentaria SA to Baa3 from A3. Both are Spain's largest lenders and are placed not far from junk level. Overall, over a dozen of Spanish banks were downgrade to junk status and Moody's had indeed downgraded six banks by four notches and ten by three. According to the rating agency, these banks have a link to Spain's creditworthiness which has deteriorated and will affect the "credit profile for Spanish banks". Also, Cyprus has asked for financial assistance from the EU/IMF to save its banks, making it the firth country in the bloc that needed bailout. Yet, the amount and terms will still need negotiation in coming days. It's expected that the required fund will range from EUR 5-10b, compared with EUR 100b required by Spain.

ECB allotted EUR 26.295b to banks in the region at its three-month refinancing operation. 50 banks bid for the funding, comparing to 33 participated in last operation in May. That's a slightly higher amount comparing to the EUR 25.13 b in three months funds maturing later this week. And, around EUR 1b of net rise in liquidity would be resulted. Meanwhile, there are speculations that since ECB won't restart the bond buying program, the central bank might opt for a rate cut next week.

In US, Fed officials continued to voice diverging opinion about additional easing. Atlanta Fed Lockhart said the he didn't think "the conditions have developed that require us to bring out bigger guns quite yet". He'd prefer to be "a bit patient" to look at incoming data. Asked what consolidations would warrant additional stimulus, Lockhart said "dramatically" slower growth and a a threat of deflation would prompt him to consideration. He said the operation twist extension announced earlier this month is the "maintenance of a policy that was in place that keeps pressure on longer-term rates". St. Louis Fed Bullard said that "current monetary policy remains ultra easy and is likely appropriately calibrated to the current situation." He said that "yo get to QE3, you would have to get a sharp drop-off in economic activity in the U.S. or a clear threat of deflation", and he doesn't see either one right now. And he warned that "ultra-easy" policy could "reignite a 1970s-type experience globally if pursued too aggressively".

On the other hand, Chicago Fed Evans continued to be dovish and urged Fed to do "more accommodation than what was adopted under the Twist". Evans said the labor market situation has been "completely unsatisfactory". And he warned that given the downside risks they're facing, "if there were any substantial downside shocks that we’re hit with over the next six to 12 months, the economy’s not in the best place". He'd support more asset purchases, MBS, to provide additional accommodation. New York Fed Dudley said that economic recovery has been disappointing and "momentum has slowed in the last few months". Dudley noted that employment slowed "considerably of late" and "unemployment rate remains elevated". And, he would look into "material data on a number of dimensions" in the coming weeks and adjust his stance.

BoE officials addressed parliament's Treasury Committee today. Governor King said that the MPC is united on the need for a "very loose monetary policy" but views diverged on "precisely how loose it should be". He noted that the bank could do more on asset purchases and there is "no immediate limit or constrain" on that. But King would prefer to see how the situation plays out first. Meanwhile, King also said he's "pessimistic" and concerned about Eurozone as situation get worse over two years.


The lower house of the Japanese parliament passed the bill to double the consumption tax in three years by a vote of 363-96. The bill will then be voted by the upper house to become law and it's very likely to be approved. The consumption tax hike was a means to ease the fiscal deficit of the Japanese economy. However, the impact is expected to be small. While the government anticipates it would help soothe the fiscal problems, opposition parties believed this would weaken demand for domestic goods, further hurting the nation's economy. Some analysts viewed that the hike would weaken that outlook of Japanese yen. On the political front, opponents of the tax hike may submit a no-confidence motion regarding the bill. The worst scenario would be resignation of the Noda Cabinet or dissolution of the lower house and elections. More in Japan Passes Consumption Tax Hike, More Political Than Economic Meaning In The Near-Term.

In order to ease the liquidity condition, the People's Bank of China (PBOC) conducted 14-day reverse repurchase operations worth of RMB 125B over the past 2 days. This was the third round of reverse repo operations, following similar money injection in January and May. The move raises the chance of another RRR cuts in coming day. Meanwhile, recent data shows that differential between RMB spot and fixing has sent a signal of capital outlook from the country, adding concerns over depreciation in RMB. More in China Watch: Reverse Repos, Capital Flow And RMB.