Despite great uncertainty, equity markets managed a positive five-day run, though at high volatility. Germany, France and Italy were the laggards, remaining in negative territory. Interestingly, implied volatilities are back at last week’s highs, reflecting the hedging activity of investors. US bonds were in demand, while investors continued to sell European bonds, this time including the high-quality German issues. Crude oil is trading above USD80/bbl, and gold is above USD1625/oz. Despite recent comments from the SNB, the euro/Swiss franc exchange rate is at 1.201 versus 1.202 last week.
Moody’s cut Spain’s government bond rating from A3 to Baa3, just one notch above junk level, and placed the country on review for a further downgrade. This comes after Spain managed to secure EUR100 billion in European aid last weekend to help recapitalise its banks. Meanwhile, the Spanish 10-year yield hit the 7% mark.
This is another downgrade that mainly confirms what the bond markets have already priced in recently. Yet it highlights the increased risk for existing bond holders due to the “preferred creditor” status of the ESM as the likely funding institution for the bailout, immediately putting everyone else in a not very attractive “subordinated” position.
Spanish banks’ net borrowings from the ECB jumped to a record EUR287.8 billion in May, climbing further from EUR263.5 billion in April, according to the Bank of Spain.
This confirms the severity of the Spanish financial system’s need for funding ahead of the country’s banking bailout. Expect the Spanish banking system to remain heavily dependent on further central bank funding, even as the solvency problem is now being addressed.
Greece’s unemployment rate jumped to 22.6% in the first quarter of this year, further up from 20.7% in the prior quarter. Even worse, youth unemployment among Greeks in the age group of 15-24 years is now at a horrifying rate of 52.7%.
Expect the painfully high unemployment rate, especially among younger people, in some southern European countries to create a dangerous and potentially destabilising potential for social unrest and increased migration pressure that will affect the eurozone as a whole for many years to come.
Eurozone inflation fell to a 15-month low. The CPI in the 17-nation currency union eased to 2.4% year-on-year in May, down from 2.6% the previous month. Although the current level is the lowest since February 2011, it is still above the ECB’s medium-term target of close to, but below, 2%.
Though inflation remains above the ECB’s medium-term inflation target, current fears of a recession in the eurozone might bring the European Central Bank to move away from its current rate freeze policy and lower interest rates at some point this year. Expect eurozone inflation to fall more amid further price drops in energy and food and an environment that makes passing price increases on almost impossible.
The number of US jobless claims rose unexpectedly last week to 386,000, as more Americans than forecast applied for unemployment benefits. Weaker economic growth prospects and the difficult business conditions are discouraging companies from hiring at the pace needed to speed up the expansion.
Although the increase is not substantial, it is another sign that the US labour market is struggling to improve and has not gained much traction recently. Expect more disappointing US employment reports in the months ahead.
US CPI inflation fell below the Fed’s 2.0% target in May for the first time in 16 months. The annual rate dropped to 1.7%, from 2.3% the month before, with gasoline prices declining by 6.8%, natural gas prices falling by 4.1% and food prices remaining unchanged. Aside from food and energy prices, however, core consumer prices still increased by 0.2% on the month, and the annual rate remained unchanged at an elevated 2.3%.
Expect continuously declining gasoline and crude oil prices to bring US headline inflation down further and core inflation to ease a little in the months ahead.
Indian inflation increased more than expected in May, as food and fuel prices surged, with the benchmark wholesale-price index rising by 7.55% year-on-year. Vegetable prices soared by 49.4% from a year earlier, while fuel and power costs climbed by 11.5%. At the same time, India’s economic expansion weakened to a near-decade low last quarter, and the country’s industrial output increased by a meagre 0.1% year-on-year in April. Production of capital goods, a key indicator of investment, even shrank by 16.3%.
The economic slowdown is adding pressure on the Reserve Bank of India to reduce borrowing costs at its next policy meeting on June 18, despite unhealthy inflation rates. This comes against the backdrop of a recent announcement by rating agency S&P, which warned that India may be the first BRIC nation to lose its investment-grade status.
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