1.2500 Remains the Balance of Power in Euro

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Market Drivers June 27th, 2012
Spain pays up to 200bp for short term money than last month
UK borrowing exceeds forecasts
Nikkei down -0.81% Europe down -0.13%
Oil at $79/bbl
Gold at $1583/oz.

Asia and Europe
CHF UBS Consumption Indicator 1.05 vs. 1.37
GBP Public Sector Net Borrowing 15.6 vs. 13.6B

North America
USD Consumer Confidence 10:00
USD Richmond Fed Manufacturing Index 10:00

EUR/USD tumbled in the wake of poor Spanish auction results but then recovered most of its losses on expectation that the brewing funding crisis in Spain my prod EU leaders to take some concrete policy action at the summit later this week. Spain was forced to pay nearly 200bp more than last month to finance its short term debt at its latest auction today. Spanish 6-month T-Bill maximum Yield rose to 3.369% vs 1.793% on May 22 while Spanish 3-month T-Bill maximum yield increased to 2.500% vs 0.879%. The bid to cover ratios were lower as well with three month diving to 2.6 from 3.95 the month prior while the 6 month saw coverage of only 2.82 versus 4.30 in May.

The latest auction results demonstrate the fragility of the country’s credit markets and put even more pressure on the EU summit later this week to address the issue of mutualization of debt in the region as financing needs become prohibitive. Spain is Europe’s fourth largest economy and as such could pose a terminal danger to the whole monetary union if it cannot come with a relatively quick solution to lower its cost of funds.

Der Speigel, the German weekly magazine just published an internal report from the finance ministry in Berlin claiming that a break up of the euro would lead to a 10% contraction in the German economy in the first year and would double the nation’s unemployment rate. Although Angela Merkel and a variety of other German officials vehemently oppose the idea of Eurobonds, markets are starting to force their hands as financing costs in Southern Europe become unsustainably expensive only exacerbating the region’s economic woes.

Meanwhile in UK a slew of monetary officials issued relatively dovish statements with BOE governor Mervyn King and MPC members Dale and Broadbent all noting that further monetary stimulus may be needed in order to aid the ailing UK economy. Governor King stressed the need for the implementation of the ECTR (the central bank’s scheme to spur lending to businesses) and stated that a cut in the 50bp benchmark rate was not out of the question but was not an attractive policy choice while QE was still ongoing.

Generally such dovish talk would be seen as negative for the currency, but cable actually rallied in the aftermath of the remarks rising to a session high as markets viewed the latest comments as simulative to the UK economy and therefore pro-risk. Sterling inched towards the 1.5640 level in midday London dealing and could push towards the 1.5700 level if equity markets rally as the day progresses.

In North America today the eco calendar is quiet once again with only consumer confidence and Richmond Fed on tap and we may have another seesaw action in both the equity and currency markets as traders continue to square up ahead of the EU summit. There is no doubt however that with financing pressures in Spain continuing to mount the stakes have been raised for leaders to do something meaningful regarding further fiscal integration of the EZ. The euro meanwhile is balanced on the 1.2500 figure and is unlikely to move much either way as markets await a decision.

Boris Schlossberg
Managing Director

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