- US stocks closed higher – Asian markets are generally showing strong gains
- Surprisingly strong Q1 Australian GDP report lifts AUD
- Spain's budget minister takes headlines – speculation about precautionary credit lines
- Seven German and three Austrian banks are downgraded by Moody's
- Focus today is on the ECB – we expect a 25bp cut (only 11 out of 60 analysts surveyed by Bloomberg agree).
Markets Overnight
Risk assets rebounded yesterday on among other things a better-than-expected ISM nonmanufacturing report – up marginally to 53.7. There is thus still high uncertainty about the near-term US economic outlook, as the ISM surveys generally point to stronger growth than indicated by last week's disappointing employment report. As investors struggle with what economic scenario to discount in the US and what risk scenario to discount for the eurozone, volatility is likely to remain high.
US stock markets closed with decent gains – the S&P500 index up 0.6% – and markets are generally showing strong performance in Asia this morning supported by a surprisingly strong Australian GDP report. The Australian economy expanded by 1.3% q/q in the first three months (consensus: 0.6). The result was a >1% spike in AUD/USD to above 0.9850. EUR/USD followed higher to trade back above 1.25.
This week's rebound in EUR/USD could suggest that consensus is not expecting an ECB cut later today, which is also the impression from analyst expectations. Our European economists, however, look for a 25bp cut today, see ECB preview: We expect ECB to cut in June.
Spain’s budget minister Cristóbal Montoro hit the news yesterday when he stated that Spain “does not have the door to the markets open” and on the subject of bank recapitalisation that “what we need is for the European institutions to get going and seek that bank recapitalization through those procedures that mean more Europe.” Apparently, Montoro was not speaking about aid to Spain, but the European process in general. However, recent comments by Montoro and prime minister Rajoy have been interpreted as a plea for "bank aid." Meanwhile, Die Welt reports that Spain may receive a precautionary credit line from the EFSF according to people familiar with current talks. Ten-year Spanish government bonds tightened 10bp yesterday.
Global Daily
Focus today: The main event today will be the ECB meeting. We expect the ECB to cut the refi rate by 25bp in response to the very weak data. The interest rate is generally used in response to the economic development whereas non-standard measures are used to address financial instability. Although market stress is clearly high, we do not think it is high enough for the ECB to intervene yet. Also we believe the ECB wants market stress to stay high for a while to keep the pressure on politicians in Spain and Greece after the election on 17 June – see also ECB preview: We expect ECB to cut in June. German industrial production is due out ahead of the ECB meeting. After a very strong March number, we had expected a decline in April. Judging from Tuesday's orders which disappointed there is some downside risk to the number. Tonight the Fed will release the Beige Book which is likely to confirm a picture of a moderate recovery and soft labour market.
Fixed income markets: A refi rate cut should be slightly risk positive, as it shows that the ECB reacts to the deteriorating macro picture and overall deflationary outlook. We expect a moderate market reaction to the lowering of the refi rate and the narrowing of the interest rate corridor. If Draghi does nothing and the tone is hawkish, this should fuel the negative sentiment as it implies that the ECB ignores the data and awaits EU politicians. If the ECB delivers as we expect, it will still not be a game changer for the eurozone. For that to happen, much bigger weapons have to be used, something the ECB is not ready to do in our view. Keep an eye on the Danish auctions today, where up to an estimated DKK5bn is expected to be tapped in 3% DGB 21 and 4.5% DGB 39. We expect very solid demand at these auctions. Read more about our expectations for the Danish central bank in the Denmark section below.
FX markets: Risks are likely skewed to the downside for the EUR today, as an ECB rate cut should trigger renewed selling, while unchanged rates would be less of a game changer. Sentiment has improved over the past 24 hours, but visibility remains low and we expect FX markets to remain volatile. AUD/USD has broken above key technical resistance around 0.9850 and is one of the few high-beta currencies that we would consider beginning to buy into following past months' sell-off (latest IMM data showed that non-commercial investors were as short AUD as in October 2008 prior to the RBA meeting and GDP report).
Scandi Daily
Denmark: We expect the Danish central bank, Nationalbanken, to cut the Certificates of Deposit rate to below zero over the summer. The next CD rate cut might very well come today if the ECB, as we expect, cuts its refi rate by 25bp to 0.75%. Nationalbanken is first and foremost expected to mirror this rate cut by lowering the lending rate to 0.20%.
Whether Nationalbanken will use this opportunity to lower the important CD rate (currently at 0.05%) to below zero depends on two factors. First, whether the ECB –against our view – lowers the deposit rate from the current 0.25% level or, second, whether foreign currency has continued to flow into Denmark ahead of the ECB meeting. Considering that EUR/DKK has traded just above 7.43 over the past couple of trading days (at or below the level that triggered intervention in May), the probability of an additional Danish rate cut implying "negative policy rates" is quite high today, but an extra Danish rate cut is by no means a done deal and developments in EUR/DKK today could be decisive. If we are going to see a rate cut in Denmark, Nationalbanken will announce it at 16:00 CET. If no change from the ECB, do not expect anything from Nationalbanken today.
Norway: In Norway the publication of the so-called Regional-Network Report by Norges Bank is due at 10:00 CET today. It will be scrutinised ahead of the 20 June monetary policy meeting to see how the Norwegian business sector has reacted to the latest euro debt woes. Until now the Norwegian economy has been very resilient. The report should not change the market view that Norges Bank will keep rates unchanged on 20 June – we share that view. 