EFSF Enhancement Hinges on Slovakia

BBH CurrencyView

• Equity markets paring back recent gains after one-week recovery ahead of Slovakia EFSF vote
• Slovakia is the last country to vote on EFSF enhancement; “Yes” vote is not a done deal
• News reports indicate China’s SWF is buying bank shares; Indonesia unexpectedly cuts rate

The euro zone debt crisis remains in focus with Slovakia slated to be the last euro zone country to vote on the EFSF enhancements later today. However, a "yes" vote is not a done deal and if Slovakia do not ratify EFSF enhancements then it is feasible that the whole deal will collapse, which would most likely lead to sharp correction in risk sentiment. The Slovak ruling coalition remained split over a deal to broaden the EFSF, which in some part is weighing on the EUR and cut into risk related trades like AUD, NZD and CAD that continue to pare back some of yesterday’s gains. As a result, European stocks are lower (snapping a 4-day rally) and bunds are higher, which is also supported in part by warnings of systemic crisis from Trichet, even though demand in Italy’s bill auction today was quite good, despite Friday’s downgrade. Elsewhere, Japan’s current account surplus narrowed to ¥407.5bln in August from ¥990.2bln in July (largest in 3-months) off the back of declining investment income.

In today’s session all eyes will be on the parliamentary vote for the EFSF in Slovakia, which is the last country to vote on the extension of the bailout fund with it on the hook for roughly €7.7bln. A “Yes” in the vote this afternoon is far from secured and the four governing coalition parties are still meeting this morning to try and hammer out a compromise, with the latest version reportedly calling for conditions to the agreement. In fact, one coalition partner had called on the government to rule out Slovakia’s participation to the new permanent rescue fund (ESM) as condition for today’s approval. Without Slovakia, the July 21 extension to the EFSF cannot go ahead, as all countries have to ratify the package. That means, Slovakia is the wildcard but we nevertheless expect it to pass the legislation and also expect markets to be looking ahead to measures used to increase the firepower of the fund as the next hurdle ahead of the 10/23 meeting. Markets also await a Troika statement on Greece sometime this afternoon. We continue to think that good news from Slovakia and Greece is likely to support the euro short-covering rally yet we would look to sell the EUR/USD between $1.365 – 1.37. Elsewhere in Europe, UK September industrial and manufacturing reflect still sluggish growth, despite the fact that the headline production print was better than expected (0.2% m/m vs. -0.2% m/m). While the headline production print does indeed look better than expected there are some caveats to the apparent strength. For one thing, there were downward revisions to July industrial production data, with the both the m/m and y/y production figures revised down by 0.2%. Secondly, momentum in manufacturing is slowing. Manufacturing production came in at +1.5% y/y, below the +1.6% consensus, while the August figure was revised up to +2.6% from 1.9%. However, the m/m reading was -0.3% m/m, from +0.1% in August — the worst m/m fall in manufacturing since April this year, while the y/y rise in manufacturing was the smallest gain since February 2010.

In Asia, FX and equities received a boost in part from recent news that China’s domestic sovereign wealth fund, Huijin, is buying shares of the 4 largest Chinese banks. A similar announcement by Chinese officials about Huijin in September 2008 came a few months before China’s stock market bottomed out, which in turn preceded a major upturn in the US stock market. Monday’s announcement may therefore prompt some optimism and has indeed been in some part a catalyst for the regional equity performance, with Chinese bank shares up over 1%. But even though we expect remain constructive on both markets, China in particular, we think the comparison is flawed. The announcement in 2008 coincided with the announcement of fiscal stimulus but this time around we think China’s has less capacity to for stimulus compared to 2008 due in part to stubbornly high inflation. Indonesia unexpectedly cut its benchmark overnight policy rate by 25 basis points to a record low 6.50% to stimulate the domestic economy as global growth slows. The Bank had been expected to hold its benchmark policy rate steady at 6.75% for the eighth straight month, but easier inflation data and euro zone debt worries prompted Bank Indonesia to shift its monetary policy focus from fighting inflation to supporting growth. Some Asian commentators said the surprise move by Indonesia could herald a major shift in monetary policy in Asia. Indeed, the weekend press speculated that China could cut bank RRR in a bid to support the local market. Elsewhere, Malaysia’s August IP surged 2.6% m/m (much stronger than expected) off the back of government spending programs and the 6.1% m/m increase in mining, leading in part to the strong MYR performance, up 1%.