European Majors Weighed Down By Greece Exit Worry

While the global equity markets stabilized last week, the currency markets didn't. Dollar, and to a slightly lesser extent the Japanese yen, continued to strengthen against other major currencies. Focus remained on the question of whether Greece will exit Eurozone, and the subsequent impact. The informal EU summit did nothing to restore market confidence as Euro weakened against all major currencies expect the Swiss Franc. Dollar' index's break of 81.78 resistance confirmed medium term up trend resumption and we'd likely see the index break through 82.5 level this week. Also, the technical development opened the door for further rise to 85 level. Strength in dollar exerted some pressure on commodities where the CRB index dived again to close at 281.95. Overall tone in dollar and yen will remain firm in near term while the relative strength of European majors and commodity currencies will depend on when the selloff in stocks resume.

Comments from former Greece prime minister Papademos that "risk of Greece leaving the euro is real" triggered some nervousness in the markets last week. IMF chief Lagarde said that Eurozone is "at the very epicenter of the crisis". She said that Greece exit from Eurozone is not a preferred option but IMF and others have to be "prepared for all possible situations". It's reported that ECB has set up a working group, run by Executive Board member Asmussen, on preparation for escalation of the crisis in Greece. There were talks that Greece exit could open doors to other peripherals including even Spain and Italy. And an immediate risks for European bank is deposit flight from indebted nations. Fitch ratings said that non-resident investors are pulling fund out of Spain and Italian public debt in Q1 and the trend of outflows could continue in the coming quarters. The flight to safe haven Swiss Franc indeed triggered speculations that SNB would impose a a deposit tax to discourage investments, or raising the EUR/CHF floor. EUR/CHF spiked higher last week but faded as the story didn't develop while Swiss officials declined to comment.

The informal EU summit ended with no concrete resolutions to deal with the sovereign debt crisis in the region. While finance leaders agreed that stimulating growth is important, they refrained from agreeing on aggressive measures. Similarly, although EU ministers voiced that Greece’s stay in the bloc is preferred, no compromise has been made on the balance between austerity and growth. French President Hollande called for the issuance of the Eurobonds, but it was, as expected, objected by Germany. Indeed, there are several prerequisites that France itself has to meet before it is ready for such sovereign bonds. More in EU Informal Summit Brings No Surprises, Members Not Ready For Eurobonds.
 
Data from Eurozone were also worrying. The region's PMI manufacturing unexpectedly dropped to 45 in May, lowest since June 2009. Services PMI dropped to 46.5, lowest since November. Both were below expectations of 46 and 46.8 Germany, largest economy in Eurozone, manufacturing PMI dropped to 45.0, lowest in almost three years. German services PMI was unchanged at 52.2. French manufacturing PMI dropped to 44.4 in May, a 3 year low while services PMI was unchanged at 45.2. The data raised much concern that Eurozone's recession would be deeper than markets have been expecting.
 
OECD latest projection showed global economy will grow at 3.4% in 2012 then 4.2% in 2013, inline with prior projections released in November. Nonetheless, OECD noted that the global economy outlook is "still cloudy" with "considerable downside risks remain and sizeable imbalances remain to be addressed." OECD also warned that "a bad outcome scenario in the euro area with implications for the rest of the world cannot be ruled out". And, it said that "any further enhancements to the existing firewall might require significant involvement by the ECB". Regarding situation in Greece, it warned that Greece exit would have "consequences that are underestimated by most observers". OECD saw slow rebound in US driven by private demand, some pick-up in Japan and moderate to strong growth in emerging economies. In Eurozone, OECD saw flat growth overall, with northern countries growing and southern countries in recession.
 
The BOE unveiled in the minutes for the May meeting that, while the members voted unanimously to leave interest rates unchanged, they were split in the asset purchase program. David Miles opted for increasing the size of purchases by 25B pound while Adam Posen indicated he might join Miles' camp at the next meeting even though he would leave the Committee when his term ends on August 31. The tone of the minutes was more dovish than the April one, reflecting concerns over the situation in the Eurozone sovereign debt crisis. More in BOE's Decision In May Ignored Deterioration Of Eurozone Crisis.
 
IMF warned that the BOE should increase its accommodative monetary easing and cut tax to stimulate the economy. As stated in the review report of the UK, "fiscal easing and further use of the government's balance sheet should be considered if downside risks materialize and the recovery fails to take off". Moreover, "if growth does not build momentum and is significantly below forecasts even after substantial additional monetary stimulus and further credit-easing measures, planned fiscal adjustment would need to be reconsidered".
 
Fitch lowered Japan's long-term currency rating by two notches from AA to A+. The more important local currency rating was also lowered by 1 notch from AA- to A+. Both were give a negative outlook. Fitch noted that the downgrades and negative outlooks "reflect growing risks for Japan's sovereign-credit profile as a result of high and rising public debt ratios". Fitch criticized that Japan's fiscal consolidation plan is "leisurely" and its implementation is "subject to political risks". Fitch projected Japan's general government debt to be 239% of GDP by end of 2012. In response to this, Finance Minister Jun Azumi reiterated that the government will accelerate the tax and welfare reform to improve the country's finance.
 
The Bank of Japan left the uncollateralized overnight call rate unchanged at 0-0.1% and the Asset Purchase Program at 70 trillion yen. The next timing for the BOJ to implement further easing would be in July. By that time, policymakers would have known the outcome of the June FOMC meeting and the Greek election. Moreover, it's also the time for the interim assessment of the BOJ's April outlook. The biggest headache for the central bank is the undersubscription of the purchase program. The situation has deteriorated since mid-April and got more pronounced in May. More in BOJ Likely To Enhance Purchases Of Long-Term Assets In July.