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Global FX
The euro area’s sovereign debt crisis continued to dominate foreign exchange market trading at the start of the year. While some positive news emerged over the past two weeks, investors remain skeptical about the region’s economic outlook as many eurozone countries have to cut government spending or raise taxes to restore fiscal discipline.
Euro sentiment got a lift after Spain and Italy successfully sold government debt at their first auction of the year, sending their government bond yields down sharply from previous auctions. The European Central Bank did not cut its key interest rate, but kept it on hold at 1% after its regular policy meeting, and ECB President Mario Draghi said that the central bank’s recent move to pump massive longer term liquidity into system had helped relieve strains in the interbank market.
However, market sentiment was hit again by a slew of bad news on January 13. Rating agency S&P’s cut its ratings on nine of the 17 euro bloc countries, including stripping France of its AAA rating, lowering it by one notch to AA+. S&P’s also said that Italy, Spain, Cyprus and Portugal were cut two notches, with the latter two given “junk” ratings. Germany kept its AAA rating. Austria, Slovakia, Slovenia and Malta were the other countries downgraded. In addition, talks between Greece and private sector lenders over a possible 50% write-off of Greek debts broke down. Reaching a deal is a pre-condition for Athens receiving the next tranche of bailout cash from the IMF and the European Union. Without fresh funds, the Greek government could run out of money and be forced to default. Developments in Europe will continue to dictate trading.
Interest Rates
To ease or not to ease? US monetary policymakers have been vocal in recent months, with some, such as St. Louis Fed President James Bullard, suggesting that the US Federal Reserve might not need to pursue further quantitative easing as recent data seem to suggest that the US economic recovery is gaining strength. But there are also others, including San Francisco Fed President John Williams and Atlanta Fed President, who advocate the purchase of more bonds to ensure that growth is sustained as they see rising risk from Europe’s unresolved debt crisis. Our view is that with the recovery gaining momentum and the Operation Twist programme, i.e., to reshuffle the Fed’s portfolio from short- to longer-term products, yet to end, the Fed could well keep policy on hold for now.
Across the Atlantic, both the European Central Bank and the Bank of England held their policy stance. The ECB did not cut its key interest rate after its regular policy meeting on January 12, but kept it at 1%. ECB President Mario Draghi seemed more positive about the euro region’s economic outlook, citing “signs of stabilisation activity at low levels’ in the eurozone economy. He further said that the central bank’s recent move to pump massive longer term liquidity into the system had helped relieve strains in the interbank market. Nevertheless, many believe that with the eurozone crisis yet to be resolved, and many governments having to cut spending or raise taxes to restore fiscal discipline, the ECB might have little choice but to cut interest rates further, perhaps as soon as in March.
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