Much volatility was seen in the markets last week as talk of additional easing from Fed, as well as rate cuts from China and RBA, boosted risk markets and pressured dollar. The hope for QE3 was then dashed as Bernanke failed to deliver in his testimony with lack of hints on QE3. Then towards the end, risk markets was then lifted again by talk of imminent agreement of bailout for Spain's banking sector. At the time of writing, there was no announcement made regarding the bailout yet. But there should be some news after the EU finance minister conference call at 4pm Brussels time. Risk rebound could extend further initial this week. But we'd like to point out that such rebound might not be sustainable since traders would remain cautious just ahead of Greece election next Sunday on June 17.
Spain did had a decent bond auction last week even though yields jumped in the auction. It's believed that Fitch's downgrade of Spain by three notches was the trigger for the rush for talk on bailout on Spain's troubled banks. EFSF, the temporary bailout fund, is expected to be involved. A solution is for EFSF to inject bonds into Spanish banks which could then be used as collateral to access ECB liquidity. Such a program would be fundamentally different from bailout of Greece, Ireland and Portugal as it's directly addressing the banking sector, not the government. Thus, additional austerity measures for the Spanish government would not be a pre-condition for the aid. In any case, we'll keep an eye on the development over the weekend.
Last week, Fitch downgraded the credit rating of Spain by 3 notches to BBB. The rating agency cited that "the negative outlook primarily reflects the risks associated with a further worsening of the Eurozone crisis, notably contagion from the ongoing Greek crisis". Fitch warned that the costs of restructuring and recapitalizing Spanish banking sector is at around EUR 60b and could be as high as EUR 100b in a more "severe stress scenario". That's more than double of it's original forecast of EUR 30b. However, the "reduced financing flexibility" of Madrid will constrain its ability to intervene in the restructuring and raise the odds of "external financing support". And, Fitch noted that Spain's gross public debt could peak at around 95% of GDP in 2015. Regarding the economy, Fitch expected Spain to say in recession throughout this year and 2013, and that's a downgraded outlook from expectation of mild recovery in 2013.
S&P rating agency said that there 1-in-3 chance that Greece will exit eurozone after the election on June 17. S&P noted that such an event could be "brought about by Greece rejecting the reforms demanded" and followed by "suspension of external financial support". Such development would "hurt the country's economy and fiscal position over the medium term". Meanwhile, S&P doesn't expect other sovereigns to follow "having witnessed the resulting economic hardships and long delay in harnessing benefits from national currency devaluation" and European officials would "additional support to discourage further departures." For example, in such case, "ECB would respond vigorously to any sustained rise in borrowing costs for other sovereigns".
ECB left the main refinancing rate unchanged at 1% although sovereign debt crisis in the Eurozone intensified. At the press conference, President Draghi unveiled that the decision was made by consensus and indicated "a few members" favored further rate cut. Yet, Draghi also downplayed the effectiveness of additional easing to the economic and financial environment. Concerning the macroeconomic developments, the ECB acknowledged that "a weakening of growth and heightened uncertainty in 2Q12. Policymaker retained that the bloc's economy would "recover gradually" but the ongoing sovereign debt crisis would have negative impact on credit conditions and dampen the "underlying growth momentum". The staff projections for the Eurozone showed that annual real GDP growth would be in a range between -0.5% and 0.3% for 2012 and between 0.0% and 2.0% for 2013. Concerning inflation, the staff forecast that annual HICP inflation would be in a range between 2.3% and 2.5% for 2012 and between 1.0% and 2.2% for 2013. More in ECB Left Interest Rates Unchanged, Draghi Questioned the Effectiveness of Monetary Policies on Crisis.
In US, at the testimony to congress, Fed Chairman Bernanke stated that "the situation in Europe poses significant risks to the US financial system and economy and must be monitored closely". He also indicated that "the Federal Reserve remains prepared to take action as needed to protect the US financial system and economy" due to the risks posed by "the situation in Europe". Regarding further easing by the Fed to boost the US growth, the Chairman stressed the Committee has a number of options to consider and if it's decided that "further action is required", the Committee would also "decide what action is appropriate or what communications are appropriate". Yet, he did not indicate what options are being considered. That's somewhat in sharp contrast to Vice Chairman Yellen's urge for additional accommodation the day before, as she said it's "appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest".
The latest Fed Beige Book described that the overall economic activity expanded at a "moderate", "modest" or "steady" pace in 11 of the 12 Districts (the pace of expansion in Philadelphia slowed slightly during the period). The report also stated that "lenders in most. Districts noted an improvement in loan demand and credit conditions". The economic outlook remained positive but those surveyed "were slightly more guarded in their optimism". Yet, the language used in the report does not seem that the market conditions would lead to QE3.
BoE kept bank rate unchanged at 0.5% and maintained the size of the asset purchase program at GBP 325b. Only a brief statement was released and focus will turn to meeting minutes to be published on June 20 instead. Sterling was lifted by stronger than expected PMI services, which stayed unchanged at 53.3 in May.
The Bank of Canada left the policy rate unchanged at 1%. Policymakers acknowledged worsening in global economic outlook and increasing risks going forward. Yet, it retained the stance that the next move of the central bank would be a rate hike, rather than a cut. This should be attributed to the relatively stable domestic recovery. Concerning exchange rate, the BOC retained the rhetoric that persistent appreciation would be detrimental to growth despite the recent decline. More in BOC Left Interest Rates Unchanged, Statement Not as Dovish as Anticipated.
RBA lowered the cash rate by -25 bps, following a -50 bps cut in May, to 3.5% in June. Deterioration in the sovereign debt crisis in the Eurozone and moderation in the Chinese economic growth were reasons triggering the reduction. Moreover, cautiousness of business and household spending which might continue in the near-term also contributed to the need for further easing. After the rate cut, policymakers believed that borrowing costs have dropped to be a 'little below their medium-term averages'. More in RBA Eases For A Second Consecutive Month. Aussie GDP showed an impressive 1.3% qoq growth in Q1, more than double of expectation of 0.5% qoq and was triple of Q4's 0.4% qoq. Year-over-year rate also jumped to 4.3% versus consensus of 3.2%. Australian treasurer Swan said hailed the data as a "remarkable outcome" and "reaffirms Australia's position as one of the strongest economies in the world". Also, Swan noted that "in through the year terms, this result is the fastest growth in over four years, which have been the most turbulent in the global economy since the Great Depression of the 1930s."
In China, PBoC unexpectedly cut benchmark one-year lending rate by 25bps to 6.31%, effective from June 8. The deposit rate was also lowered by 25bps to 3.25%. That was the first interest rate cut since 2008 and followed successive reserve requirement ratio cut in November, February and May. More in China Cut Interest Rates, The First Time In Over Three Years. The China Banking Regulatory Commission said it will delay the implementation of the tighter capital rules until January 2013. The delay will now give a reasonable transition period to meet the requirements while maintaining "appropriate credit growth". Meanwhile, CBRC also said that China will "cut the risk-weighting levels for loans to small firms and individuals to increase credit supply to those areas and provide more support for the real economy". Separately, China cut state-set gasoline and diesel prices for the second time in a month as another stimulus move. Inflation data from China saw CPI slowed more than expected to 3% yoy in May, lowest in two years. PPI also dropped more than expected by -1.4% yoy. Cooler inflation should give leeway for China to add more stimulus.
Technical Highlights
Dollar index tried to stage a rebound last week but momentum was weak. Current development suggests that consolidation from 83.54 will likely extend further in near term. But outlook remains bullish with 80.89 support holds and recent rally is expected to resume sooner or later for 100% projection of 74.72 to 81.78 from 78.09 at 85.15.
Despite dipping to as low as 1.0210 last week, USD/CAD was supported above mentioned 1.0206 support (38.2% retracement of 0.9799 to 1.0445 at 1.0198) and recovered. Lost of momentum towards the last hours indicates that consolidation from 1.0445 is going to extend further. Initial bias remains neutral this week for some more sideway trading. On the downside, break of 1.0211 will bring deeper correction to 61.8% retracement at 1.0046. On the upside, break of 1.0445 will confirm resumption of rise from 0.9799 and should target 1.0522/0656 resistance zone next.
In the bigger picture, current development indicates that rebound from 0.9406 is resuming. Such rise is either a correction to fall from 1.3063 or the third leg of the whole consolidation pattern from 2007 low of 0.9056. In either case, USD/CAD should target 38.2% retracement of 1.3063 to 0.9406 at 1.0803 first and possibly further to 100% projection of 0.9406 to 1.0656 from 0.9799 at 1.1049 before completion. Break of 0.9799 support is needed to invalidate this view or we'll stay bullish even in case of deep pull back.
In the longer term picture, there is no clear indication that the long term down trend from 2002 high of 1.6196 has reversed even though bullish convergence condition was seen in monthly MACD. Current development dampens the case that fall from 1.3063 is resuming the such down trend. But there is no change in the long term bearish view so far. A break of 0.9056 low is still anticipated after all the consolidative price actions complete.
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