Crucial week in both US and Euro area

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10 December 2012

• Crucial week in both US and Euro area
• FOMC QE decision tops the calendar list
• Italy causing renewed pessimism in the Euro area

This week has always been singled out by the market. It the final key week of 2012 and admittedly so since it includes the much-awaited Fed decision. More specifically, on Wednesday the 2-day FOMC meeting concludes with the market expecting an announcement of another round of QE. Our economists look for $40bn per month UST purchases – close to market average – although forecasts extend to $85bn/month, a level which would surprise the market. Expectations for QE1 and 2 programmes initiated a sustained sell off period in UST however this time it should be different especially in the short-term. The fiscal cliff negotiations continue as the lame duck period comes to an end and the market continues to question the possibility for an agreement before the year-end. We continue to expect no resolution before year-end which will put a natural barrier to the ‘optimism’ about the US economy following the Fed announcements. Opposing this sentiment is the heavy US supply over these 2 weeks starting with the 2 year auction tomorrow. $66bn will be offered this week and a total of $179bn until the Friday 21st December. Adjusting for redemption/coupons and the net Twist impact, the next market outflow should reach $136.5bn – the largest 2-week outflow during 2012.

Turning to the Euro area and the week can not get more action-packed as we have an Ecofin meeting on Wednesday (starts at 13.30 GMT), another Eurogroup session on Thursday (9.00 GMT) and the final EU Summit for 2012 (Thursday, Friday). The Ecofin has the arduous task of finalizing the negotiations on the SSM (including coverage, non-Euro members’ role, a specific timetable) as the German side continues to disagree with the catholic coverage of ECB. In the very likely case that no hard agreement is reached, the EU council should reach a compromise if EU policy makers want to meet the 1-Jan-13 deadline and finish 2012 on a high note. Then, the Eurogroup will deal with Greece, Cyprus and Spain. The Greek buyback was completed on Friday and while the initial reports point to €27bn being offered, the Greek govt remains positive for a ‘final’ result closer to €30bn – which is line with the Eurogroup’s expectations. Official results could be announced today however only after the Euro working group (the preparatory meeting to the Eurogroup) has been informed and is satisfied in releasing the €10.2bn in the form of 6-month EFSF bills needed to pay for the buyback. Further official announcements are expected during the Eurogroup and especially the date of the release of the €34.4bn tranche. Cyprus will update on its progress with the Troika and discuss the debt sustainability issue while ESM should confirm the disbursement of the €39.5bn worth of securities to Spain for the ongoing bank recapitalization. Finally, the EU summit – following its recent failure to agree on the EU budget– will deal with the 4-presidents report on EMU’s future, any unfinished business from Ecofin/Eurogroup and touch once again on the growth agenda.

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What was not widely expected this week is the developments in Italy. On Thursday, Berlusconi’s party withdrew its support on a parliamentary bill aiming to disassociate itself from the ongoing progress and position for the upcoming elections – the same time that Berlusconi announced another bid for the PM seat. Monti could resign immediately unless he secures assurances that the 2013 budget will be approved which means that we will remain until the budget vote. In the meantime, the Italian Tesoro prepares for the penultimate BTP auction and despite the developments, our expectations remain for a new 3 year on Thursday despite the recent 20bps widening vs. Bunds in the 10yr area.