It's Time to Get Creative on Ukraine's Debt

Russia-Ukraine Conflict

Summary:

Public and private sector lenders must work together.

In June, government representatives from around the world came together to create the right conditions for Ukraine's recovery and reconstruction effort, which should be led by the private sector. The Ukraine Recovery Conference included welcome commitments of support in the fields of commercial risk insurance, co-investment and guaranteed lending as well as technical assistance in supporting Ukraine's candidacy for European Union membership.

While such official support is a prerequisite for the country's successful recovery and reconstruction, commercial external debt remains in limbo following the debt service suspension agreed in August 2022. Consequently, market access for both the sovereign and, critically, the private sector remains closed off and the budget is overwhelmingly reliant upon official sector financing.

Achieving the Ukraine government's stated priority objective of normalising the debt situation in the first half of 2024 and quickly re-establishing market access requires urgency and careful planning. This is going to entail some creative thinking about debt and debt sustainability, and a higher level of partnership and trust between official and private sector lenders.

Prudent fiscal and debt management over the 2015-22 period has meant that, 16 months into the conflict, Ukraine's debt-to-gross domestic product is still below 80%, which is well below 2015 levels. While this ratio may rise a bit over the coming year, a dynamic, construction-driven recovery will create ample space to absorb new debt while lowering key debt ratios towards sustainable levels.

However, the damage done by Russia's illegal invasion has created large multi-year financing gaps – $25-30bn annually under the International Monetary Fund's baseline and downside scenarios – which will need to be filled by assumptions about debt relief, market access and reparations payable by Russia.

The IMF's current financing arithmetic assumes that Ukraine will be able to re-establish access to international capital markets relatively soon after the end of the programme in 2027 (it took just two years after the 2015 debt restructuring). But the amounts assumed don't even touch the sides of what is required when set against Ukraine's reconstruction needs.

Who should pay?

There is broad recognition that official sector funding commitments alone will not be enough to plug the gaps. Attention at the URC was therefore rightly focused on the inevitable need for a major financial contribution from frozen Russian assets. Assumptions about this will clearly need to be incorporated into the financing arithmetic before the parameters of a debt treatment can be negotiated.

Conventional debt relief can play a relevant but ultimately limited role in closing Ukraine's financing gaps. War-time bilateral lending, multilateral lending and domestic debt are likely to be excluded from any restructuring perimeter. All payments on legacy commercial and bilateral debt are already subject to debt service suspension. The stock of restructurable public debt – Eurobonds, mainly – accounts for less than a quarter of the total public sector debt stock, and its share is rapidly shrinking. The savings that can realistically be generated from a conventional debt treatment are therefore very limited.

The appetite of investment funds which hold the Eurobonds to commit new funding, on behalf of the predominantly western pensioners and individuals whose assets they manage, will be closely correlated to the treatment of the existing debt. Restructured bonds will also need to carry coupons to compensate holders for the cost and risk of holding them, which is likely to be a source of contention with official creditors, understandably reluctant to see payments on Eurobonds subsidised, in effect, by western taxpayers.

A private sector solution

How can the private sector provide the official sector with the reassurance that much more private funding will be available to Ukraine once a debt restructuring is complete?

One solution is to combine a conventional debt relief exercise with a new money component. Proceeds from new lending would ensure strong positive cashflows from the private sector over the IMF Extended Fund Facility programme period, provide liquidity for government liability management and make available a large pool of capital for financing the budget and reconstruction.

Creditors would provide debt relief via a combination of maturity extensions beyond the end of the programme and lowering debt claims to create space in the debt arithmetic for committed new lending. Collective action clauses would be invoked on the base terms, but creditors participating in such an exchange on a voluntary basis would receive future financing rights eligible for use in post-restructuring sovereign issuance.

FFRs would work like discount vouchers, allowing the investor to recoup the upfront haircut over time by purchasing new bonds at a fixed discount to the par issue price, but only in return for committing considerable new money alongside.

By the time Ukraine restructures its debt in mid-2024, the stock of sovereign Eurobonds will stand at roughly $24bn. Let's assume that investors, in addition to extending maturities past the horizon of the programme, agree to exchange a $6bn upfront haircut for an equivalent notional amount of FFRs. Those FFRs would allow the ministry of finance to issue new bonds with a market-determined coupon. Investors would settle newly issued bonds at a pre-agreed percentage of 80% of their par value, with the remaining 20% settled in FFRs.

The stock of $6bn FFRs would be exhausted once Ukraine had issued $30bn of new debt, and this would raise $24bn of new money, or $6bn annually over a four-year period, of which perhaps a quarter would be required to service the restructured Eurobond stock. A secondary market in the vouchers would develop to allow creditors with lesser or greater appetite or capacity to lend to sell or accumulate rights. Secondary market pricing would also allow both creditors and the issuer to glean important signals about appetite for new issuance. The government might see an opportunity to lock in the principal reduction by repurchasing rights itself.

Combining upfront debt relief with credible new money commitments from the private sector would provide significantly higher certainty about financing assurances, reopen market access immediately and allow for the credible front-loading of upsized private sector funding assumptions that help close identified financing gaps and address official sector concerns about burden-sharing.

Reaching an understanding on the role that the offshore private sector will play in financing Ukraine's public sector from 2024 onward – one that inextricably ties the resolution of legacy debt with new money commitments – is critical to restoring Ukraine's credit rating standing and complementing future private investment initiatives in the real economy. Having that discussion sooner rather than later will only serve to reduce the scope for delays once a debt operation becomes practicable and strengthen the laudable objectives of the URC.

Source Timothy Ash and Alex Garrard

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Thomas

Political

Since Russia invaded Ukraine last year, North Atlantic Treaty Organization (NATO) meetings and summits have been receiving significantly more attention compared to previous years. And there are several big-ticket items on the agenda at the summit in Vilnius, Lithuania, which began on Tuesday (Jul 11).

The foremost issue is, of course, NATO's future military support to Ukraine in its ongoing war against Russia, particularly in the wake of reports of weapon delivery delays and the United States' controversial decision to send cluster munitions to the Ukrainians.

The allies will also discuss Ukraine's potential membership in the group. Ukraine is seeking an invitation and a roadmap to eventually join NATO, which the US and Germany, in particular, have resisted while an active war is occurring.

The members will also agree on the first major overhaul of NATO's military plans since the Cold War and an increase in their individual defence spending. NATO Secretary General Jens Stoltenberg is looking for commitments from all 31 members to spend at least 2 per cent of their gross domestic product on defence - something that was considered an aspiration rather than a baseline a decade ago.

NATO's interest in the Asia-Pacific

The other invitees receiving considerable attention are four leaders from the Asia-Pacific: Australian Prime Minister Anthony Albanese, New Zealand Prime Minister Chris Hipkins, Japanese Prime Minister Fumio Kishida and South Korean President Yoon Suk-yeol. The four will be in attendance for the second year in a row, following last year's NATO summit in Madrid.

While NATO's outreach efforts to the Asia-Pacific region are still in the infancy stage, they have generated some criticism in recent days. Former Australian prime minister Paul Keating called Stoltenberg a "supreme fool" for boosting the bloc's ties with the region. And French President Emmanuel Macron is reportedly opposed to the opening of a proposed NATO liaison office in Tokyo.

With NATO so heavily focused on Ukraine at the moment, its interest in a region halfway around the world does raise some questions. Why are these four leaders becoming regular features at a summit for European and North American countries?

First, these countries have been among the most prominent members of the international coalition supporting Ukraine and sanctioning Russia. So, their presence at a security conference where Ukraine will be discussed makes sense.

More importantly, though, the Indo-Pacific region featured prominently in NATO's 2022 Strategic Concept, a key document that outlines the alliance's values, purpose and role.

For the first time last year, the document referred to China's ambitions and policies as a major challenge to NATO's security, interests and values. It also specifically addressed the growing cooperation between China and Russia, which NATO sees as a threat to the established rules-based international order.

As such, the Strategic Concept called the Indo-Pacific "important for NATO, given that developments in that region can directly affect Euro-Atlantic security".

This makes the case quite clear for NATO to strengthen its existing partnerships in the region and develop new ones.

What These New Partnerships Will Look Like

Policy analysts have debated the merits and consequences of this expanded level of cooperation.

But despite hesitations among some commentators, the four Asia-Pacific countries generally want to move in the direction of stepping up their cooperation with NATO.

Indeed, if the Madrid summit served as an opportunity for the four Indo-Pacific partners to showcase their support for Ukraine and pledge stronger commitment to future collaboration with NATO, the Vilnius summit will serve as a benchmark to assess the progress that's been made.

This is why, in the lead-up to the summit, NATO has been working to formalise its partnerships with the four countries.

Japan and Australia have been at the front of these efforts. Japanese media reported last week that Tokyo and Canberra have wrapped up negotiations with NATO on a new agreement called the Individually Tailored Partnership Program. This programme specifies the key areas of cooperation between each country and the NATO bloc.

New Zealand and South Korea are working to finalise their individual agreements with the alliance, too.

The partnerships will largely focus on areas of global concern, such as maritime security, cybersecurity, climate change, outer space, and emerging and disruptive technologies (including artificial intelligence).

And from a defence standpoint, NATO and the four partners will aim to improve the "interoperability" of their militaries - the ability of different military forces and defence systems to effectively work together and coordinate their actions.

This might entail deepening the knowledge of each other's military assets, improving the relationships between their soldiers and other military personnel, and expanding joint drills.

Deepening Relations Between NATO and Indo-Pacific Partners

The intensifying and deepening relations between NATO and its Indo-Pacific partners can be interpreted in two ways.

First, these partnerships form another important link in the expanding network of diplomatic and security ties between the US, its Western allies and the Indo-Pacific region. They complement partnerships like AUKUS and the Quad.

Beyond this, we can also view these agreements in the context of NATO's evolving outreach with the rest of the world over the past couple of decades.

Previously, NATO's collaborations with Indo-Pacific countries involved pooling resources for security operations in non-NATO members, such as the Balkans in the 1990s and Afghanistan in the 2000s.

Nowadays, strengthening these partnerships is seen as a vital part of responding to the new challenges and threats posed by Russia and China.

Of course, this does not mean we will see NATO military equipment or troops permanently stationed in the Indo-Pacific. Nor would it be realistic to expect the Indo-Pacific countries' military contributions to Ukraine to lead to a more permanent set-up in Europe.

Similarly, while all of this is aimed at intensifying security cooperation among US allies in the Indo-Pacific, this is in no way a prelude to the creation of a NATO-like collective defence pact in the region.

However, given the complexities of the current tensions with Russia and China, there is a clear need for greater coordination and cooperation among a larger group of countries. These new partnerships can be effective in addressing everything from disinformation and maritime security to cyber defence and competition in space.

Chinese President Xi Jinping and Russian President Vladimir Putin would obviously prefer these partnerships to slow down. Indeed, China has criticised the proposed NATO liaison office in Tokyo as an attempt to "destroy regional peace and stability".

China and Russia might even find some comfort in seeing the clear differences among the four partners as to their desired level of engagement with NATO.

However, all four Indo-Pacific countries can agree on one fundamental fact - they expect to see more competition with both China and Russia in the future, not less.

Source: CNA

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Alex

Economic

Beginning in Australia, the Westpac-MI Consumer Sentiment survey delivered a lacklustre update on confidence. At 81.3, the headline index remains firmly entrenched at extremely pessimistic levels, an outcome that has only been associated with major economic dislocations over the survey's near fifty-year history. Driving this sustained weakness in sentiment has been a marked deterioration in views over the economy's prospects and family finances for the year ahead, with these sub-indexes now 10% and 16% below their respective long-run averages. The cost-of-living remains a considerable constraint for households, the sub-index covering spending intentions on 'major household items' nearly 40% below its long-run average.

Another key theme discussed by Chief Economist Bill Evans after the July survey's release is the impact of inflation and interest rates on confidence. Curiously, the RBA's decision to leave the cash rate unchanged in July offered no support; indeed, sentiment was much weaker after the meeting than before (77.9 vs. 88.0). Available data gives context to this result. Evidence over the past year suggests inflation has had a greater impact on confidence than interest rates. May's deceleration in the Monthly CPI Indicator from 6.8%yr in April to 5.6%yr and the consequent rally in sentiment pre-RBA to 88.0 also support this thesis. However, in noting "Some further tightening of monetary policy may be required", the RBA made clear that policy will likely have to be tightened further to get inflation sustainably back to target. The material chance of further hikes and a lengthy period of above-target inflation arguably drove confidence back down to 77.9 post-RBA, 1.6% below the final June outcome.

The emerging weakness evident in business conditions is becoming more consistent with consumers' pessimistic view on the state of the economy. The NAB business survey indicates that the current assessment of business conditions has taken a material step back over the last two months, down from +15 in April to +9 in June. With forward orders posting consecutive declines over May/June against a backdrop of soft and fragile business confidence, the survey's shift in tone is clear, foreshadowing the prospect of a further slowing in the economy over the remainder of the year.

Before moving offshore, it is worth highlighting that RBA Deputy Governor Michele Bullock has been appointed as RBA Governor for a seven year term commencing September 18. This development comes at a time where the RBA's monetary policy processes and communication guidelines are being assessed and modified in light of the Government's Review.

Events offshore this week also provided a number of notable headlines.

The Bank of Canada raised rates again by 25bps to 5% as fears of persistent inflation prompted action. This is the second rate hike since the BoC decided to pause earlier this year. Inflation has eased off the back of lower energy prices; however, broad-based strength remains elsewhere. Spending data shows evidence of excess demand across the economy, with household consumption driving GDP growth in the March quarter and more timely indicators like retail sales suggesting consumers have plenty of cash to splash. This comes alongside a housing market that is starting to find its floor. New projections suggest the CPI will hover around 3% for a year. The BoC experience is a perfect example of why central banks must be wary of the risks of ending their tightening cycle too soon.

South of the border, the US CPI made headlines as it came in softer than expected at 0.2%mth for both headline and core inflation. There were clear signs of a broad-based deceleration as momentum in goods and services ex-shelter continued to slow. However, shelter continues to cause concern, contributing a whopping 2.1ppts to annualised headline inflation in Q2 thanks to its 35% weight and 6.0% gain. Here is evidence that shelter has the capacity to create at or above target outcomes for inflation by itself should rent inflation hold up rather than decelerate as is our base expectation.

The Federal Reserve's July Beige Book was also constructive for the inflation outlook. Economic activity was reported to have "increased slightly since May", employment only "modestly". Most significant for inflation is that the "unusually high [labour market] turnover rates in recent years appear to be returning to pre-pandemic norms" and contacts "in multiple Districts reported that wage increases were returning to or nearing pre-pandemic levels". Despite this, signs of labour market slack have yet to show up meaningfully. Initial jobless claims fell to 237k, driving down the four-week average to 246.8k.

Across the Tasman meanwhile, the Reserve Bank of New Zealand kept rates steady at 5.5% in line with expectations. The statement noted "monetary conditions are constraining domestic spending as expected" and there was nothing to indicate their thinking had changed vis a vis keeping the OCR on hold until the second half of 2024. The next meeting will reflect the Committee's view of the June CPI print and labour report. Should either come in stronger than expected, the central bank will be keen to get on the front foot and raise the policy rate by 25bps. It is Westpac's view that they likely will.

Over east, the Chinese June price outcomes were weak, the CPI flat year-over-year and the PPI down 5.4%yr. Base effects are significant for these outcomes, the impact of Russia's invasion of Ukraine on supply chains and energy and commodity prices falling out. However, excess capacity across the economy and a continued push to grow industry further amid a modest post-COVID rebound is also at play.

To counteract some of this weakness, the government has eased key policy rates and increased liquidity. They are also likely encouraging lending by the banks behind the scenes. Aided by these steps, M2 money supply rose 11.3%yr off a strong base in 2022, and new loans came in well above expectation in June at CNY3050bn. Benefitting both now and the medium-term, the trade balance remained wide in June at US$70.6bn albeit shy of expectations, US$74.9bn. To sustain this sizeable income inflow, Asian demand has to make up for weak and deteriorating developed-world demand.

Source: Westpac Banking Corporation

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Cohen

Economic

An accelerating dollar slide could be a U.S. gift to its allies by helping them catch up with its impressive disinflation.

Seeing headline U.S. inflation tick below 3% for the first time in more than two years in June electrified world markets this week by encouraging a belief the Federal Reserve can finally end its 15-month credit tightening this month.

Bond yields recoiled and stock markets surged to 2023 highs.

But it was the dollar exchange rate that took the heat of 'peak Fed' excitement and the greenback's DXY index against the most traded currencies plumbed its lowest levels since April 2022 - its biggest weekly drop of the year so far.

That dollar index is now down a whopping 4.5% in just six weeks, propelling the euro to its highest since March 2022, sterling to a 15-month peak and Switzerland's franc to its best level in eight years. Even the recently ailing yen jumped.

While these moves are still part of an unwinding of the supercharged dollar gains of 2021 and 2022, they can still pack a punch for world economies dancing with recession.

A dollar slide of this size and speed has typically elicited yelps of pain from U.S. trading partners. All things equal, it both squeezes their exports to the U.S. while sucking in cheaper U.S. imports at home.

But given the dominant battle against inflation and serial 'cost of living' crises, the dollar's swoon right now may be far more welcome than usual overseas.

The impressive reversal of headline U.S. inflation back close to the Fed's 2% target - from last year's bruising 40-year cresting at 9.1% - has been a major relief stateside and well ahead of schedule. The June readout is already below the International Monetary Fund's best guess for the yearend.

But that sort of progress has been lacking in Europe so far.

Euro zone headline inflation - which peaked about one percentage point above and three months later than the U.S. equivalent last year - was still 2.5 points above it last month. The UK picture is even worse - peaking at more than 11% last October but still almost six points above U.S. inflation in May as we await the June update from Britain next week.

But a sliding dollar may aide the catch-up, even at the margin.

Not only does Europe directly import cheaper U.S. goods and services as a result of a lower dollar, it cheapens the cost of dollar-denominated energy, commodity and food prices still aggravating consumer prices everywhere.

And, even if less welcome, it dampens domestic demand via exporters' margin hits that can also further sap inflation. U.S. Exporting Disinflation Via Dollar Slide_1

U.S. Exporting Disinflation Via Dollar Slide_1

U.S. Exporting Disinflation Via Dollar Slide_2

Headspin

The crux of any trade-off on that score is that additional disinflation via exchange rates, even if marginal, will remove at least some pressure on the Bank of England and European Central Bank (ECB) to 'outhawk' the Fed once the latter's done.

Right now, money markets assume the Bank of England will have to leapfrog an expected Fed 'terminal rate' of 5.25% to 5.50% and lift rates another 100 basis points from here to more than 6.0% over the next year.

The ECB will likely stay shy of peak Fed rates, but an expected move to 4.0% policy rates by year-end will involve two quarter point hikes after the Fed has stopped.

Can a sharp dollar plunge head that off if it bites deeper into stubborn inflation?

Sceptics will say the complicated mechanics of exchange rate "pass-through" to consumer inflation means the effect will be too slight, particularly within the euro zone where the bulk of trade is between member states. They also contend that residual price stickiness is now mostly in domestic services-related inflation that's less sensitive to currency shifts.

However, the dollar's role in energy and commodity pricing and more generally in international trade invoicing means the pulse can be sizeable.

Underlining that point late last year, when warning of an inflation pulse from a then-rising dollar, the IMF pointed out while the U.S. share of world goods exports had declined by four percentage points to 8% since 2000, the dollar's share in world exports has held at around 40%.

It also cited estimates that on average a 10% dollar move had a 1% impact on inflation over time - albeit likely skewed to emerging economies more prone to trade swings.

And even if the scale of the impact on Transatlantic trade may be arguable, a steep dollar drop could help European countries offset a likely fading of the negative year-on-year base effects in crude oil prices -- base effects that have been central to the drop-in headline inflation rates this year.

But then, as so often, the financial market arguments become a bit circular and head spinning.

In some respects, the idea reverses again the 'reverse currency wars' theme first adopted by Goldman Sachs over the past year - where it posited that an excessively strong dollar exaggerated inflation and interest rate rises outside the U.S. and potentially amplified economic downturns there.

A time-limited dollar drop now may be more benign than a simple reversion to a new 'currency war'.

And a steep enough fall now may just neutralise the rationale for the move in the first place - by helping rein in expectations of overseas tightening once the Fed has stopped.

Self-regulating or dizzying?

The gift of dollar weakness may simply be some borrowed time and relief from monetary overkill. U.S. Exporting Disinflation Via Dollar Slide_3

U.S. Exporting Disinflation Via Dollar Slide_4

Source: Yahoo

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Kevin Du

Cryptocurrency

Cryptocurrencies were testing year highs on Friday as a run of favourable regulatory and investment moves have started to shift momentum in markets that had been stuck in a rut for months.

Bitcoin traded at its highest price since June 2022 overnight, touching $31,818 on the Bitstamp exchange. It is up more than 90 per cent for the year so far and nearly 30 per cent in a month.

Second-biggest token Ether had its best session since March and Ripple, which a U.S. judge ruled could be legally sold on public crypto exchanges, soared 73 per cent.

"The regulatory environment is changing," said Matthew Dibb, chief investment officer at crypto asset manager Astronaut Capital. "And by what we have seen in the last 24 hours, it could be for the better."

The Ripple ruling came together with fraud charges against the former boss of bankrupt crypto lender Celsius Network, which are contested, and on the heels of moves into the market by finance firms BlackRock and Fidelity.

Investors say it is driving a mood shift.

"Ripple stakeholders were waiting for some regulatory clarity. Yesterday the court seems to have provided just that," said Justin d'Anethan, head of business development in Asia at Keyrock, a digital assets market maker in Hong Kong.

The language remains somewhat unclear, he said, but finding that XRP tokens sold on public crypto exchanges were not securities under law "probably serves as a precedent."

It unleashed a rally in smaller cryptocurrencies called "altcoins," with tokens such as Solana, Matic and Stellar up between 15 per cent and 50 per cent and shares in exchange Coinbase up 24 per cent to a year high.

"If centralised crypto projects aren't securities, then that may make it more likely for the Commodity Futures Trading Commission to be primary regulator for the industry, which is something most people in crypto would prefer," said Greg Moritz, chief operating officer of crypto hedge fund Alt Tab Capital.

He said further cases would probably shed more light on how courts will treat private crypto offerings.

Traders said liquidity was low on the altcoin moves, but steadily improving in bitcoin and ether. Turnover for Coinbase stock was the highest in 14 months on Thursday, giving weight to a move that has more than doubled the stockprice in a month.

Momentum

Crypto assets are now trading near or above levels plumbed when the collapse of the FTX exchange last November plunged the sector in the depths of what has been called the "crypto winter".

FTX imploded when it was unable to honour a rush of withdrawals and its failure, exposing customers to losses, added momentum to global regulatory efforts at reining in the sector, especially to protect small investors lured by fast returns.

China has all but banned crypto. U.S. investigators raking over FTX have accused founder Sam Bankman-Fried of multibillion-dollar fraud, to which he has pleaded not guilty.

Celsius founder Alex Mashinsky also pleaded not guilty to his charges on Thursday and to be sure, plenty of other legal challenges remain pending and market setbacks are expected.

Coinbase and bigger rival Binance face lawsuits, which they are contesting, from the SEC and in Binance's case from other regulators as well. A top SEC official said last month the industry has "an ethos built around noncomplicance."

The entrance of traditional finance businesses into crypto, bringing in large sums has evoked memories of the rally that lifted bitcoin 300 per cent in 2020.

The world's biggest asset manager, BlackRock, filed to launch a bitcoin exchange traded fund last month and earlier in July exchange operator Cboe refreshed its filing for a similar fund to be run by asset manager Fidelity.

"We'd gone through this long period of just consistently negative news to make the space look pretty grimy," said Chris Weston, head of research at brokerage Pepperstone in Melbourne.

"For the first time in a while, it's been consistently positive news coming though and that means you've got momentum."

Source: CNA

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Devin

Political

Spaniards will interrupt their summer holidays to vote for a new parliament on July 23, after an election campaign in which no one party has established a decisive lead and featuring irate exchanges between the main candidates for prime minister.

Polls show the conservative opposition People's Party (PP) of Alberto Nunez Feijoo beating Pedro Sanchez's ruling Socialists (PSOE), but failing to secure an absolute parliamentary majority.

To secure a majority of the 350 seats that it needs to form a government, the PP would almost certainly have to ally with anti-immigration, anti-feminist Vox, a move that could give the far-right a role in government for the first time since the end of Francisco Franco's dictatorship in 1975.

Why was the election called?

A national election was due by December, but Sanchez unexpectedly called a snap election after the left did badly in local elections in May.

The move was an apparent attempt to wrongfoot the PP, forcing it to campaign while also negotiating uncomfortable post-local ballot coalition deals with Vox.

Which way could it go?

Spain's Snap Election: What You Need to Know_2

Polls suggest the PP will win just over a third of votes and the PSOE just under a third. Potential kingmakers Vox, and popular Deputy Prime Minister Yolanda's Diaz's leftist bloc, Sumar, are both tipped to win 14%.

As the PSOE hoped, the PP's popularity was slightly dented by its negotiations with Vox, some of whose extremist views were incorporated into the coalition agreements between the two right-of-centre parties.

Sumar meanwhile sealed an alliance with leftist parties and gained ground.

However, about 54% of voters thought Feijoo won an ill-tempered live television debate with Sanchez, against 46% for the prime minister, according to a Sigma Dos survey. Spain's Snap Election: What You Need to Know_3

Spain's Snap Election: What You Need to Know_3

What happens on the day?

Polls open at 9 am, with 37.4 million Spaniards are registered to vote, including 2.3 million abroad and 1.6 million for the first time. At least 2.5 million have registered to cast ballots by post.

A total of 350 lower house deputies and 208 senators will be chosen. Party lists for lawmakers are closed, so voters pick a party rather than a specific candidate, but chose up to three regional senators.

Polls close at 8pm, except in Canary Islands which are an hour behind, with the winning party expected to be announced before midnight.

What happens after that?

New parliament must be constituted by August 17, when the oldest lawmaker is nominated temporary speaker. Lawmakers vote the same day to pick a permanent speaker, an event that indicates how blocs are aligning and their relative strength.

King Felipe VI will begin meeting party leaders soon after to hear their pitches, and must then put forward a candidate for prime minister.

There is no time limit for the candidate's negotiations to form a government.

If the candidate fails to obtain an absolute majority in a parliamentary vote, a re-run requiring only a simple majority is held 48 hours later. If they lose again, the king has to pick a new candidate.

Might there be another election?

If no candidate secures a majority within two months of the first vote, new elections have to be called.

Spain has held four in the past four years because coalition agreements could not be reached, with some such impasses lasting as long as six months.

Analysts agree that this time, if the PP and Vox cannot cut a deal, further elections are a distinct possibility.

Any other potential issues?

The vote will take place at the height of summer, with temperatures likely to top 40 degrees C in parts of the south.

With millions of Spaniards on holiday and more voting by post than ever, unions and the PP have expressed concerns that some risk being disenfranchised due to administrative bottlenecks.

Voter participation has declined from 80% in the election after Franco's death, to 66% in November 2019. This time, voter apathy coupled with holidays and hot weather could dent turnout further.

Source: Reuters

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Samantha Luan

Forex

USD: Army of bears growing stronger

The disinflation narrative has landed heavily on the dollar, and a look at the next couple of weeks – in the lead up to the July FOMC meeting – shows that there aren't many other data releases that can drastically turn the tide for the greenback. In yesterday's FX Daily, we mentioned a parallel with December's dollar sell-off and stressed how the dollar positioning was considerably more stretched to the long side back then. This is not a secondary aspect, especially given the wide post-CPI moves pointed at some large position squaring dynamics, which suggests the dollar is now looking at an even more balanced positioning now.

That being said, it's hard to build a strong counterargument to the bearish dollar momentum, especially after PPI data yesterday confirmed inflation is dissipating in the US. Our US economist notes that the key story for CPI and the PCE deflator down the line is the ongoing normalisation in corporate profit margins. Should economic headwinds intensify, there would be scope for a proper contraction in margins (as companies push up price competition) and that can provide extra help in taking inflation well below target next year.

With CPI and PPI decelerating, it will be interesting to see how quickly inflation expectations are declining. The University of Michigan will publish expectation surveys today, and that will be the biggest event for markets. There are no scheduled Fed speakers, and FOMC participants will stir away from public remarks from today as the pre-meeting blackout period kicks off. Yesterday, James Bullard surprisingly announced his departure from his role as President of St Louis Fed. He has been the most hawkish FOMC member recently, but the St Louis seat is not up for voting until 2025.

In other central bank news, the Australian Treasury Minister Jim Chalmers decided not to reappoint Philip Lowe as RBA governor, and appointed deputy governor Michele Bullock as the new head of the central bank. Her latest comments have been in line with the broader RBA messaging, stressing data dependency and leaning on the hawkish side of the spectrum. She will take over in September, and the policy implications should be limited for now.

DXY broke below the 100.00 barrier yesterday, and the next logical support would likely be at 99.00. A pause or upside correction in the dollar could come at any time given the large swings of the past couple of days. This morning's moves suggest we could see some re-adjustment/stabilisation happen today with a quiet calendar. However, downside risks will keep prevailing for the dollar in the near term.

EUR: Rally looking a bit stretched

EUR/USD has taken off on the back of US disinflationary bets and a large unwinding of dollar positions. Our short-term fair value model shows that the pair has now entered overvaluation territory (around 2.0%), a clear signal that the move has exceeded what can be explained by market factors (rates, equities).

As discussed above, it seems difficult to build a strong counterargument to the bearish USD narrative at this stage and while some correction after a large and possibly overstretched move is possible, the near-term outlook may stay broadly bullish on EUR/USD.

The eurozone calendar only includes the trade balance data for May, with European Central Bank speakers scheduled. EUR/USD may stabilise around 1.1200 today, or even correct lower back to the 1.1170-80 area in the currently highly volatile environment.

For the pound, this could translate into a pull-back to the 1.3050-70 area. Looking ahead, GBP surely faces some clearer downside risks than the euro given the greater room for a dovish repricing of Bank of England rate expectations compared to the ECB's. The latest wage data pointed at another 50bp hike in August, but next week's CPI release is still an important risk event.

SEK: Sticky inflation, again

Inflation in Sweden kept decelerating at a slower pace than expected, especially in the core measure – which is what the Riksbank primarily focuses on. June CPIF data released this morning showed a slowdown from 6.7% to 6.4%, although the key measure that excludes energy only moved from 8.2% to 8.1%.

The Riksbank has repeatedly signalled how a weak krona was likely hindering efforts to tame inflation, and data seem to confirm those fears. The late-June hawkish pivot helped halt the SEK slump, but it's really been all up to the external environment to drive the huge rally of the past few days. SEK and NOK have rallied 6% against the dollar this week, a sign that those were indeed the two major shorts still being held to play the prolonged US inflation/inverted yield-curve narrative.

The krona's recovery is offering some breathing room for the Riksbank, but evidence of sticky inflation – paired with those of rebounding long-term inflation expectations – all suggest a hike at the September meeting is quite likely. That, however, may well be the last move of the cycle, as the krona may also find a more stable path to recovery.

The plunge in EUR/SEK below the 11.50 mark surely raises some sustainability questions. We have discussed above about the risks of a re-adjustment after large moves: SEK would in theory be hit harder than other currencies in a correction, although inflation data this morning may at least make it less vulnerable than NOK. This morning, the troubled Swedish landlord, SBB, is reportedly in talks with bond investors. This is still a story to keep a close eye on, and remains a downside risk for SEK.

CEE: Rally slowing down but we still expect more

This morning, we have already seen the data from the industry in Romania for May, which posted 1.8% year-on-year. Later today, we will see the final inflation data in Poland. We expect a confirmation of the decline from 13.0% to 11.5% YoY. Later in the day, we will see the current account results for May in the Czech Republic, Poland and Romania, which have improved significantly in recent months.

CEE FX slowed its rally yesterday, however we still expect more across the board. Global sentiment remains the main driver in our view and this should continue to support the region to stronger levels today. For the Hungarian zloty, we expect to get below 373 EUR/HUF, the Czech koruna closer to 23.700 EUR/CZK and the Polish zloty to 4.430 today.