Euro rallies after EU summit on Greece delivers comprehensive package
25/Jul/2011 • Currency Updates•
Markets spent last week once again focused on the European sovereign crisis. Peripheral spreads blew out to all-time highs on Monday, but peripheral sovereign bonds quickly recovered, and their rally gained steam as details of a bolder than expected package for Greece, Portugal and Ireland trickled out starting Wednesday. Risk assets also rallied in sympathy, and treasuries and bunds sold off. In FX markets, the dollar traded weaker as the flight-to-safety bid faded and Congress failed to reach a deal with the President on the debt ceiling issue.
Markets focused on the release of the MPC minutes from the last meeting. Again, the vote to keep both rates and the size of the balance sheet unchanged was 7-2, and Adam Posen was still the sole member to vote for additional asset purchases. The tone of the minutes was unequivocally pessimistic, and members worried both about the soft data and about the possible spill over of the European debt crisis into the UK. All this was overshadowed by the news out of the EU summit, however, and sterling spent the week as a low-beta version of the common currency. GBP rose about 1% against the dollar and lost about half that amount against the euro.
The critical EU summit held mid-week was considerably more productive than markets had expected. A detailed description was given of the second Greek bailout and private sector involvement (PSI), the latest euphemism for creditor haircuts. Critically, the emphasis shifted from punitive austerity to economic growth and debt sustainability. In addition to debt relief, interest rates will be lowered for all three countries receiving aid. We consider this change in tone to be quite critical, and the market agrees so far with our assessment. The euro rallied strongly against both the dollar and sterling, and peripheral spreads ended the week down very significantly. On the negative side, Eurozone PMI sentiment indices dropped considerably more than expected in June. It remains to be seen how much macroeconomic damage the delays in reaching workable solutions have wreaked on the European economy.
Market relief over the European summit, together with the lack of agreement on lifting the US debt ceiling weighed heavily on the USD last week. Macroeconomic news out last week was mostly second tier, and did not change the basic feel of a sputtering recovery. For now, however, it seems that the dollar is content to be a negative proxy for risk appetite, and as equities and commodities both rose strongly, the greenback ended the week down over 1% in trade-weighted terms.