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WEEK IN FOCUS: 18/07/11 - 22/07/11

Last Friday, after the European cash close, the EBA published its 2011 stress-test results on European banks, which showed that 20 of the 90 banks tested failed when using data up to the end of last year. In comparison only 8 banks fell below the key 5% core tier 1 level when capital raising measures up to the end of April this year were taken into consideration. Despite the later number being lower than initial estimates of 10-15, it is yet to be seen if the market will give its approval on the results given that despite Portuguese banks passing the tests, Moody’s downgraded the debt rating on 7 Portuguese banks late last Friday. Meanwhile, the Eurozone debt crisis is likely to provide further concern to the market with contagion effects still a key consideration of many investors and as Greece looks ahead to roll-over EUR 2bln worth of 3-month T-Bills on Tuesday. Separately, Eurozone policy makers are far from united on the exact implementation of measures to tackle Greece’s mammoth debt worth around EUR 370bln. The Vima newspaper cited ECB’s Bini-Smaghi at the weekend as favouring the use of the EFSF to buyback Greek government debt in the secondary market. This measure, according to Der Spiegel, would slash the country’s debt burden by approximately EUR 20bln if the buyback were done at market price. However, Germany is categorically against any such plan and is still insisting on enhanced participation of private investors, which in the eyes of rating agencies would most probably result in a selective default. Elsewhere, EU’s Rehn has been quoted as saying, in the Sunday Business Post, that maturities of Irish loans from the EFSF should be lengthened and interest rates lowered. However, France remains reluctant to buy this idea as long as Ireland doesn’t increase its corporation tax rate from 12.5%, a level which the Irish government has defended fiercely. It is also worth noting that the EU/IMF team arrives in Portugal this week to provide technical assistance with country’s debt as part of its regular review, this coincides with the Portuguese Parliament who debate and vote on their proposed austerity measures on Wednesday.

On the other side of Atlantic, the US is struggling with its own economic woes, with no clear sign of an agreement between the Democrats and Republicans on the issue of raising country’s debt ceiling in sight. This week lawmakers will likely work on a plan proposed by the US Senate Republican leader, McConnell, which would essentially authorise the Obama administration to raise the debt ceiling – without any mandatory spending cuts – as long as it is not rejected by both the House and the Senate. Meanwhile, the Senate majority leader, Reid, wants to add about USD 1.7trl in spending cuts to McConnell’s plan. It is to be noted that the US needs to raise the debt ceiling as well and map out a credible deficit reduction plan in order to avoid losing its AAA sovereign rating. Markets as well as the rating agencies will keep a close eye on developments on both these aspects this week.

Elsewhere, US earning season will be in full swing, with as many as 10 DOW companies reporting this week. Bank of America, Goldman Sachs and Morgan Stanley are among key lenders releasing their quarterly results. We’ll also have earnings from the likes of Apple, Intel, AT&T, General Electric, Qualcomm, Johnson & Johnson among many others. In terms of the economic calendar, German IFO and ZEW surveys, together with manufacturing and services PMI data from the Eurozone are due to be released this week. Meanwhile, the UK will see its retail sales report, allied with the release of BoE’s July minutes, where markets will look for the MPC voting pattern on the benchmark interest rate and any indications on whether Adam Posen has any further supporters of increasing the asset purchase facility. Housing data will dominate economic releases from the US with housing starts, building permits and existing home sales all due this week, which will provide the market an insight into the health of housing sector a key component to the fragile US recovery. Finally in fixed income, around EUR 32bln worth of government debt is coming onto the market this week with the Spanish/German 10yr bond yield spread likely to re-test Euro-era record levels as the market continues to fret over potential contagion. Spain will auction 12 and 18 month T-bills on Tuesday followed by EUR 3-4bln in 10yr and 15yr debt on Thursday.