Flows, Market Snapshot and Axes…
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Last week, Ireland released results of its bank stress test. The four tested institutes need to raise an additional EUR 24bn. Additionally, a meaningful restructuring of the Irish banking sector will leave only two commercial banks working on the island. Senior bondholders are protected from any losses as the new Irish government finally gave in to the ECB’s demand. Within the ECB itself, a dispute emerged as to whether Irish banks should get access to a tailor-made liquidity facility. The ECB Governing Council could not agree on this. Instead, it decided to accept Irish government bonds as collateral irrespective of their rating.
Analysts praised the stress test for its credibility and its rigorous assumptions. Investors praised the decision not to force senior bondholders to participate in the costs. Irish government bond spreads tightened moderately following the announcement. Nevertheless, S&P downgraded Ireland by one notch to BBB+. Quite remarkably, though, the rating agency provided a “stable outlook”, signaling that with the stress test and the elections out of the way, a rating bottom might be reached for the time being. Elsewhere in the EMU periphery, the situation in Portugal is worsening by the day. The President called for elections on 5 June, only 10 days before the country has to service more then EUR 5bn in debt and coupon payments. The interim government confirmed that it does not have the power to request an EMU/IMF bailout program. The deficit figure for 2010 was revised up. In a reopening of a 15-month bond, the finance agency managed to sell EUR 1.6bn at a depressed yield of less than 6%, most probably to certain investors and not to the wider market. In the Western universe, the most remarkable development involved a string of hawkish comments from various Fed members (Kocherlakota, Lacker, Bullard, Fisher). Investors quickly adjusted their expectations for the Fed funds target rate which in turn supported the US dollar. Economic data released over the past week confirmed the well-known pattern of steady growth, improving labor market conditions in the US and accelerating inflation pressure in the EMU. Markets have managed to overcome the Japanese disaster (so far), unrest in Libya is exerting only a moderate upward pressure on the oil price (so far), the EMU summits are history and the Irish stress test is out of the way. The next challenges are waiting in Portugal – and in Frankfurt. The ECB will raise the refi rate by 25bp to 1.25% on Thursday. The press conference should deliver hints as to whether the next rate hike should be expected in the near term (May or June) or whether the ECB will remain patient in removing monetary accommodation further. The Bank of England will also hold a rate-setting meeting on Thursday. We expect that the MPC will remain divided on a first rate hike, with the majority still voting in favor of unchanged rates. In the US, FOMC member speeches might feed the discussion about when to stop QE2 and when to start hiking rates.
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