Slovenia on the brink ... when will this Eurozone crisis end?

Week Commencing Monday 8th April 2013

Overriding Market Themes

Credit rating agency Standard and Poor’s has reaffirmed the UKs triple A credit rating, at least for the short term, while citing continues concerns about the economy. It did confirm however that it may still seek to downgrade the UK form the highest rating in the future, if economic conditions worsened. Seen as a vote of confidence in the coalition’s budget busting austerity measures, the Treasury has been quick to capitalise on the move, which it used as a springboard to confirm its commitment to fiscal consolidation.  February's downgrade by Moody's, another of the big three rating agencies, was seen as a political embarrassment to the government, which had promised to protect the UK's credit rating when it was elected in 2010. Despite the “relatively” good news in keeping a triple A rating, confidence continues to remain elusive for good old England. With the UK economy shrinking in the fourth quarter and Markit Economics stating last week that its industry surveys point to growth of a measly 0.1 percent in the three months through March, we won’t be putting up the bunting just yet. 


Meanwhile on the continent, Slovenia’s creditworthiness is deteriorating at a near-Cypriot pace as investors speculate a banking crisis will force it to follow the island nation and become the sixth euro country to need aid. Credit Default Swaps insuring Slovenian debt for five years soared in price, increasing as much as 66 percent to a six month high of 414 bps at the end of March. Slovenia’s recently elected government is struggling to prop up its banking sector, which was hit badly by recession and saddled with bad loans worth about a fifth of the country’s GDP. CDS’s on Slovenia, which accounts for 0.4 percent of the euro economy, have now surpassed those for Spain, Italy and the area’s newest member, Croatia. Slovenia adopted the euro at the start of 2007, becoming the first post-Communist nation to make the switch, and its economy outperformed that of Europe’s common currency area for most of the past decade before the recession and collapse of the construction industry hit its banks. Being such a small player in the euro-area as a whole, will a Slovenian bailout further increase the risk of contagion? Probably not. Like Cyprus, Slovenia is tiny in the grand scheme of things, although it continues to demonstrate the need to more acute fiscal harmonisation around the region. 


In the US, the economy added just 88,000 jobs in March, the lowest increase for nine months. The number was much weaker than the rise of approximately 200,000 predicted by economists, and will inevitably raise new concerns about the strength of the US economic recovery. At the same time however, the rise did manage to drop the US jobless rate to 7.6% from 7.7% in February. The US economy continues however to outperform its European rivals, and with a swath of US news out this week, all of which is expect to show continued growth, we expect good tidings for the world biggest economy as we move deeper into April. 

GBP This Week

With the Pound bouncing back against the US Dollar last week, especially as the interest rate and asset purchase levels announced by the BOE turned out to non-events. The pound took advantage of awful US Non-Farm Payrolls and a sudden reversal in risk aversion, but can it sustain its gains into a second week? We start with Manufacturing Production, which is by far the biggest UK release of the week. The index has not looked good in recent releases, with three declines in the past four releases. After a decline of 1.5% in March, the markets are expecting a turnaround, with the April forecast calling for a gain of 0.4%. We then move to Tuesday’s 10 year bond auction, which has seen yields on 10-year bonds slowly rising, and climbing above 2% in the previous release for the first time in a year. We anticipate further increases in this round in line with the recent downgrade of UK Government Debt. Finally, the NIESR GDP Estimate should be a good watch. The indicator has not shown much activity of late, and posted a decline of 0.1% in the March reading. The markets will be looking for the indicator to push into positive territory this time round.


Despite some gains last week, the UK economy continues to drag on the Pound. Construction and Services PMI continue to point to a contracting in the first quarter, despite the reasonably strong Services PMI posting. With the US and Europe posting disappointing figures last week, it seems that the Pound was given a short break from its usual battering. If UK Manufacturing does not meet expectations, we expect to see the Pound reverse its recent gains, as it did early last week after the disappointing Manufacturing PMI release.

USD This Week

We start a big USD week with Ben Brenanke speaking at the Federal Reserve Bank of Atlanta’s 2013 Financial Markets Conference in Stone Mountain. We expect him to prattle on about the advantaged of a low interest rate world helping growth domestically and internationally, as well as the recent unemployment declines. We then move to Wednesday’s FOMC Meeting, which led to a stronger dollar on its last release a month ago. Thursday sees Unemployment Claims and US Retail Sales, with a drop and a rise expected respectively continuing to show the US economy is performing well. Finally, Friday’s University of Michigan Consumer Sentiment saw a drop to 71.8 in March, which was the lowest reading for a year. This was mainly down to respondents venting anger at the government’s inability to deal with its fiscal commitments, and with inflation now steady at 3.3 percent and 10 year inflation expectations dropping, we expect a small rise to 78.8 this time round. 


With the Dollars losses last week, we expect to see some reasonable reversals this week, especially in the light of the large number of US releases this week, all of which are thought to be Dollar positive. Against the Euro, which continues to recover from the Cypriot saga, we should see some small gains, although expect a range to become apparent. Against the Pound, we would imagine the 2 cent gain will be removed by the middle of the week, especially if Manufacturing Production is poor.

EUR This Week

Last week saw the Euro swing from positive to negative territory as Mario Draghi hinted about a rate cut in either May or June. Despite the uncertainty, he did reiterate the ECB’s support for the Euro-area, which has gone some way to stem concerns over a euro-area breakup. In light of increased monetary stimulus from Japan and no near end in sight to QE in the US, we have seen the Euro gather some support. This week’s data set appears to be relatively light, with the Eurogroup and ECOFIN meetings on Friday and Saturday respectively most likely being the highlights. Industrial production is probably the most important release of the week, with production in France and Germany falling indicating the EU is struggling to emerge from recession. Some analysts believe the ECB should respond to these weak figures and expedite its rate cuts; however this is unlikely until the Cypriot/Slovenian situation is at least partly resolved. A gain of 0.3% is predicted now. 


We remain relatively neutral on the EUR moving into the week, as a light data set removes the technical trading element from the currency. One the one hand we have the continued European sovereign debt issues, which weighs heavily on the single currency. On the other hand, we have extensive monetary easing from the US and Japan. Expect EUR/USD to trade a range therefore in an absence of any disastrous news from Slovenia.

In Other News

Looks like the Falkland Islands may well have struck gold, or oil at least. The offshore oil discovery may generate the Falklands government revenues of about $160,000 per person each year when it starts production in 2017, according to London-based consultants Edison Investment Research. However with the Argentine government seeking to sue any company involved in Falklands drilling, we doubt the black gold will be flowing any time soon. 


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