Once more the story of the day is the EU sovereign crisis with risk appetite continuing to run for the proverbial exits. Risk-correlated assets were sold off around the globe, although EU credit-default swaps did see a reverse in pricing. Greece's government bond spreads widened and consequentially brought market-fear pressure on Portugal, Ireland and Spain as well. Commodities were hit hard with crude and metals down sharply. The EURUSD fell through the 1.3000 level, trading as low as 1.2940 during the Asian session. For traders not overly concerned with the German parliament's hawking tone or Greece's required adhesion to ultra-strict fiscal measures, there's a fresh source of EU anxiety. Market rumors are circulating that Spain is considering requesting a €280bn bailout. To quash the rumors, Spain's Prime Minister Zapatero affirmed that Spain had no requested a bailout, although his language was curiously past tense. Clearly, the formal announcement of the Greek bailout failed to sooth investor sentiments as they continue to weather the worst recession of our time. The reason the announcement failed is because the market is focused on mid-to-long term expectations for the EU and the Euro, not immediate damage control for Greece. There is a acute chance that Greece will fail to meet the necessary fiscal requirements for a myriad of reasons: social pressure, political change, double-dip global recession etc. If negative growth continues in southern Europe, it will further weigh down business activity in northern Europe and possibly drag the entire EU into a slow, steady tailspin. While we expect a small EUR correction due to extreme short positioning, we are still overall bearish on the currency. We harbor growing concerns that the EU has lost the first battle in what will eventually be a lost war.
The Norges Bank will meet this week and we expect the central bank will keep its policy rate unchanged at 1.75%. That said, we are in the very slim minority, as most analysts are looking for a 25bp hike. The bank's own guidance is very direct in signaling further tightening stating, the Executive Board's strategy is that the key policy rate should be in the interval 1.50% - 2.50% in the period to the publication of the next Monetary Policy Report on 23 June unless the Norwegian economy is exposed to new major shocks. The Norwegian economy is generally expected to outperform its European neighbors and increases in housing prices and wages are expected to generate inflation pressure mid-term. Most analysts believe the Norges Bank strategy will be to gradually increase pre-emptively rather then wait for a spike in inflation that forces rapid tightening. However, in the last Monetary Report the central bank took a cautious tone on the recovery and highlighted growth is not high and some industries are still in decline (manufacturing and building and construction activity) with recent data underperforming expectations. In addition, events in the EU have been a mentioned by other Central Banks and the Norges bank will not just turn a blind eye to this potentially destabilizing event. With inflation in check, ongoing event risks in Europe, and growth still fragile we suspect the Norges Bank will take a wait-and-see approach this time around.