EUR held to ransom

Capital markets remain focused on the parliamentary vote in Greece and on the long-term funding program negotiations. In the near term, the key deadline remains the vote in the Greek parliament on austerity measures, scheduled for tomorrow. The successful outcome to last week’s confidence vote supports market expectations that the austerity measures will pass.

However, according to Prim Minister Papandreou, this vote is too close to call! So much so, that EU members are putting the finishing touches to contingency plans to deal with the possible consequence of a sovereign default in the Euro-zone. Financial markets are pricing in an +80% chance of this occurring.

A positive austerity voting outcome should bring only limited relief to this already nervous market. Without a comprehensive funding program with clarity on the degree of participation for private bondholders, the EUR will remain vulnerable to headline risk.

The US$ is a stronger in the O/N trading session. Currently, it is higher against 13 of the 16 most actively traded currencies in a ‘subdued’ session.

Yesterday’s US consumption spending data was noticeably weaker than expected due to the downward revisions to prior months. The -0.1% decline in real-PCE for May was in line with market forecast, and largely reflects the supply driven decline in auto-sales. The surprise was in April, where real consumption spending was revised down from +0.1% to -0.1%. That pulled the annualized growth rate of real consumption spending for the first two-months of this quarter relative to first quarter to +0.6%. Capital markets expect second quarter growth to slip into the +1 to +2% because of weak consumption throughout May.

There were fewer surprises in the price data. The PCE price index matched the CPI with gains of +0.2% in the headline index and +0.3% in the core. Analysts expect the indexes to soften next month due to declining energy prices in the headline index, fewer energy spillover effects in the core and an easing of supply pressures in the auto industry.

The dollar is higher against the EUR -0.08%, GBP -0.30% and lower against CHF +0.14% and JPY +0.09%. The commodity currencies are mixed this morning, CAD -0.22% and AUD +0.13%.

The Canadian dollar, despite trading within its recent tight range, continues to inch closer to parity, touching a three-month low yesterday, as investors remained wary ahead of the vote in Greece tomorrow, to approve an unpopular austerity plan and as commodity prices fall.

Last week, the loonie posted its biggest weekly drop in two-months as risk-averse investors sought refuge in the most liquid of assets, the greenback. Higher yielding growth assets have come under pressure as investors risk-appetite goes ‘walkabout’ on the back of commodities softening on speculation that global economic growth may falter. US consumer spending, which accounts for +70% of US economic activity, came in flat for the first time in nearly a year, and slipped -0.1% when adjusted for inflation yesterday. Personal income also rose less than expected. The disappointing data added to the general cloud over the global economy.

The loonie is headed for the first two-month loss in a year, as rising concern that debt-strapped Greece and other Euro-peripheries will default and an economic slowdown in the US makes interest-rate increases by the BoC less likely.

With the Fed cutting its growth objective for the remainder of the year has higher yielding growth sensitive currencies trading under pressure. Expect the Canadian dollar to be subjected to the pull of either risk or risk aversion trading strategies. CAD is vulnerable now with US data likely to continue to print weak into mid-July (0.9878).

The AUD dropped through key technical support levels to an eleven-week low after the dollar rallied in the O/N session. The currency remains under pressure on concerns that a Greek austerity plan will not resolve Europe’s sovereign-debt crisis and will continue to dampen appetite for higher yields. Supporting the selling pressure was the RBA’s board minute’s for June reaffirming a noncommittal Central Bank. Concern that global growth is slowing is prompting traders to bet that the RBA will cut interest rates. Governor Stevens may reduce his benchmark rate by 19bp over the next 12-months, compared with bets on a +25bp hike on June 1st.

Governor Stevens and company cited growing concerns in Europe, downside surprises in US data and deterioration in non-mining related industries as giving the board enough reason to remain on hold until further notice. The minutes were also less explicit than RBA Governor Stevens’ speech last week on emphasizing upcoming data like the CPI report. The market is pricing a no hike in August unless inflation and employment surprised on the upside and the situation in Greece clears up sufficiently for a powerful rebound in risk appetite. Global data needs to improve before we can embrace any rate hike policy thinking. Investors remain better sellers on rallies (1.0452).

Crude is higher in the O/N session ($91.05 +0.44c). Oil prices fell yesterday as Greece’s debt crisis and the decision to tap global oil reserves continued to weigh on prices. The IEA said its members would release crude from their SPR’s. They intend to inject +60m barrels of government-held stocks onto the global market, immediately increasing world supply by +2.5%. Weaker global data is also put the commodity under pressure this week. US consumer spending stagnating last month and a preliminary Chinese PMI showing that factory output may rise at the slowest pace in 11-months in June is questioning global demand.

Previously, ‘tightness in the oil market has threatened to undermine the fragile global economic recovery’. Year-to-date, unrest in the crude-producing Middle-East and North Africa has sparked hefty price gains. According to analysts, this supply move is significant, as it ‘represents a reach by member countries for the remedy of last resort to high oil prices’. The spike in energy prices is being cited ‘as the reason for the economic slowdown and this is a reaction to that’. Analyst’s note, that from its peak this year, crude is off-20%.The technicals see strong support first appearing at around $87.

Gold prices yesterday were little changed as indecisive moves in FX-land and ongoing negotiations about a potential bailout for debt-laden Greece have left the market in ‘walkabout’ mode. Last week, the commodity fell $50 after a pledge by EU officials to stabilize the region’s economy slashed demand for the commodity as a haven. Margin calls in other asset classes also required investors to raise fresh capital by selling the yellow metal.

Gold is viewed by some investors as a hedge against inflation, and the surprise release of crude oil stockpiles from developed nations’ reserves damped sentiment amongst investors for rising prices. The commodity could still see a strong pullback if the Greek austerity measures win parliamentary approval tomorrow, as it would likely reduce short-term investor concern and demand for safe-harbor assets.

The commodities dependency on the buck and the outlook for US rates is likely to remain intact for now. This ‘one directional trade’ is far from over, with speculators continuing to look to buy the metal on these deep pullbacks ($1,502 +$5.70c). Technical analyst’s see $1,485 as the first level of real support.

The Nikkei closed at 9,648 up+71. The DAX index in Europe was at 7,129 up+22; the FTSE (UK) currently is 5,753 up+32. The early call for the open of key US indices is lower. The US 10-year backed up 5bp yesterday (2.91%) and are little changed in the O/N session.

The US yield curve rose from almost a record low ahead of this week’s three-treasury auctions ($99b-2’s, 5’s and 7’s), on bets that the Greek Socialist Party will get parliamentary approval for its austerity measures needed to secure a troika bailout.

The US 10-year benchmark was able to back up for the first time in four days as Chancellor Merkel’s coalition government welcomed proposals from French banks and insurers on voluntary participation in a roll-over of Greek debt. The market to date has seen a steady grind to lower yields without a significant pullback. Investors seem to be waiting for the ‘storm to pass until there is some clarity from Greece’.

The US Treasury auctioned $35b 2-year notes yesterday. The issue tailed +1.2bp at a record low yield of 0.395%. It was the first tail in three months and was to be expected because of record low yields. The auction had a 3.08 bid-to-cover ratio compared to an average cover of 3.32 in the six-prior auctions. Indirect bidders took +22% of the issue (the smallest take down in three-years) versus an average of +30.5%. Direct bidders took +13.5% of the issue versus a +14.5% average. Today, we get to take down +$35b 5-years and tomorrow $29b 7-years.

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