ECONOMETER

Nervousness or simply just impatience is growing ahead of the EU Summit beginning on Thursday. The formal application by Spain for a banking bailout of up to EUR 100 billion has started the process while Greece is looking to renegotiate the terms of its bailout following the formation of a new government in the country.

European equities are not reacting well, however, with sharp declines registered yesterday following by drops in US stocks. Risk assets have come under pressure as noted by the sharp 12.5% jump in the VIX index overnight while the USD index continued to strengthen.

Interestingly despite the rise in risk aversion, many high beta currencies are holding up reasonably well. Indeed, those with the biggest sensitivities to risk such as ZAR, MXN, PLN and EUR have failed to drop while implied currency volatility has been falling over recent weeks. This may reflect the beginning of summer trading conditions rather than resilience in currency markets but nonetheless, it suggests a dose of FX calm ahead of the EU summit.

EUR/USD came under pressure hitting a low around 1.2471 failed to extend losses. The bad news intensified and included the formal Spanish bank aid request, Moody’s downgrade of 28 Spanish banks’ ratings, Fitch’s decision to cut Cyprus’ ratings to junk status, lack of concessions from German Chancellor Merkel who maintained her strong stance against common Eurobonds and inflexibility about the use of rescue funds. As a result it looks increasingly unlikely that a concrete plan will emerge from this week’s EU summit. EUR/USD will find technical support around 1.2442 and resistance around 1.2584.

One currency that has failed to perk up is the Indian rupee. New measures announced yesterday to shore up the INR including a $5 billion increase in the foreign investment cap in government bonds and an increase in the limit for domestic firms to borrow from overseas of up to $40 billion, failed to have more than a fleeting impact on the currency.

What were missing were measures to increase exports and cut excise duties. The measures left markets who had expected much more, with a taste of disappointment. While the measures are a decent starting point clearly much more will need to be done to appease markets and reverse the gloom among INR bears.