Eurogroup confirms Spain bank bailout

The Euro is off to a great start of a new week, up almost 1% against the US Dollar following news that Spanish banking sector will be given a capital injection of up to €100 bln.

Luis De Guindos, Spanish finance ministry, confirmed the bailout will be made available to try to solve and recapitalize its banking system. De Guindos announced the decision and has pointed that the conditions are in better terms than market but haven't explained that terms.

"The Eurogroup has been informed that the Spanish authorities will present a formal request shortly and is willing to respond favourably to such a request," stated the Eurogruop official note.

"The loan amount must cover estimated capital requirements with an additional safety margin, estimated as summing up to EUR 100 billion in total," continues the EU paper. The €100 billion will be managed by the FROB and the new "debt will count as a public Debt," De Guindos pointed.

De Guindos also said that the "financial aid will be focused in the 30% of the banking system; the other 70%, as the IMF report said, are in good conditions to afford stress conditions."

According to De Guindos, the Eurogroup haven't asked more austerity measures (later denied) but Mauricio Carrillo, FXstreet.com analyst, questioned it in his twitter account (@MCarrilloFX), "How do you expect to pay it if Spain GDP will contract in 2012 and 2013 ?" In addition, Carrillo comments that "current conditions are 6% interest," so better terms is any number below 6%.

Wolfgang Schäuble, German FinMin said that "EFSF is ready to provide €100 billions to Spain" but "the Iberian country will have to pay back bank aid."

The Eurogroup also ask in his statement that they will monitorize deficit targets and austerity program. "The Eurogroup is confident that Spain will honour its commitments under the excessive deficit procedure and with regard to structural reforms, with a view to correcting macroeconomic imbalances in the framework of the European semester. Progress in these areas will be closely and regularly reviewed also in parallel with the financial assistance."

On Sunday, El Pais elaborated further on why the supposedly soft loans are way cheaper, around 3% according to sources familiar with the negotiations between Spain and its European partners.

"For one to accept 3% rate compared to 6% for 10 Year Spanish GUCs, there obviously has to be some security incentive. It also means that, as we suggested yesterday, subordination has come to Spain" the Spanish leading newspaper notes.

El Pais continues: "In return for subsidized rates, Spain will cede sovereignty over its financial system, but also lose tax sovereignty, contrary to what the Government said yesterday."

There is risk that the bailout money may stop coming in the foreseeable future if Madrid fails to readjust its budget deficit, according to market analysts.

Spain now joins Greece, Ireland and Portugal as the forth EU country to ask for a bailout. So far, the EU and IMF have committed over 500 billion euros to shore up debt-stricken member states.

According to Megan Greene, Director of European Economics at Roubini Global Economics: "Unfortunately, it is very unlikely to succeed in drawing a line under concerns about Spain’s solvency. In the absence of economic growth, a bailout for Spain’s banks will be followed by a bailout for the sovereign as well."

Meanwhile, Yanis Varoufakis, Professor of Economics at Athens University and renowned Euro crisis observer, has no doubt Spain’s ‘bailout’, exactly like Ireland’s, will no succeed.

"All that has happened is that proud nations like Ireland and Spain have now joined Greece and Portugal in the Workhouse that is the EFSF-ESM; the Temple of Ponzi Austerity. Structured as a giant CDO, the whole edifice is spearheading the disintegration of the Eurozone, with untold costs for the whole of Europe. If Greece was the canary in the mine, and Ireland the harbinger of a systemic Eurozone-wide crisis, Spain is the portend that Europe’s Reverse Alchemy has now began, dissolving the fabric of countries that, unlike Ireland, are too large to ignore" Yanis said.

EU leaders mull true fiscal union - The German weekly Spiegel

A true fiscal union may be taking shape. The intentions from European FinMin is that eurozone members mau have limited borrowing capacity subject to joint approval, the German weekly Spiegel said in a report to appear Monday. They could only spend funds previously matched by potential prospects of revenues, the report said, not citing sources.

Countries with need of additional capital should present its case for approval to the Eurogroup of eurozone finance ministers, which would then decide if the request was justified.

The controversial eurobonds, using all eurozone members as collateral, would then be issued to finance the debt, the report said.

The mooted plan and its details is currently being drawn up by European Commission head Jose Manuel Barroso, European Council president Herman Van Rompuy, Eurogroup head Jean-Claude Juncker and European Central Bank chief Mario Draghi, Spiegel said.

Japanese Yen Aims Higher as Eurozone Crisis Returns to the Spotlight

The Yen continues to track US Treasury bonds, with the correlation between a trade-weighted index of the currency’s average value versus its top counterparts and the benchmark 10-year note now at 0.75 (on 20-day percent-change studies). This puts risk sentiment trends firmly in control of price action, with the Yen aiming to follow bonds higher if risk aversion sparks a flight to safety across financial markets, and vice versa. Most critically, this turns the spotlight onto Eurozone debt crisis worries in the week ahead.

EU finance ministers are expected to hold a conference call on Saturday where Spain is rumored to ask for help recapitalizing its banking sector, where costs are estimated to be as high as €100 billion. This would mark escalation of the festering crisis considering Spain is the fourth-largest country within the currency bloc, making its rescue by far the most involved to be attempted thus far. A statement is expected to emerge following the call and will set the tone for markets at the start of the trading week.

Looking beyond Spain, sovereign risk jitters were already waiting to reemerge as markets inch toward Greece’s second attempt at a general election on June 17. The fate of Athens’ commitment to its obligations under the terms of the EU/IMF bailout – and thereby Greece’s membership in the Eurozone – appears to be in the balance. The possibilities appear grim. A win by the pro-bailout New Democracy party will bring an attempt to renegotiate aid terms, which seems bound to stoke uncertainty and fuel risk aversion. Alternatively, a victory by anti-bailout Syriza threatens to see Greece abrogate the arrangement altogether.

On the economic data front, the focus is on the US calendar as the key uncertainty in the global economic growth outlook remains the degree to which a choppy recovery in North America can offset headwinds from weakness in Europe and Asia. Expectations call for Retail Sales to drop for the first time in 11 months in May while the University of Michigan gauge of consumer confidence ticks lower and New York State manufacturing activity slows in June. Industrial Production is likewise forecast to decelerate. This stands to compound upward pressure on the Japanese unit as global output expectations darken while QE3 hopes linger, keeping Treasury prices well-supported and capping yields.

The possibility of intervention from Japanese authorities remains an ever-present wild card. If risk aversion metastasizes into outright panic and USDJPY volatility sees a dramatic pickup, policymakers may step in anew. Japan seemed to have far greater success with quiet management of the exchange rate through late 2011 than with previous big-splash intervention efforts, but one does not necessarily dismiss the other if a particularly sharp plunge takes the pair back toward the 76.00 figure. - IS

Euro Jumps As Markets Respond Positively to Weekend Developments

• China data not as bad as many had been expecting
• EU assistance to Spanish banks is well received by markets
• Risk correlated assets well bid in early week
• Euro still see higher towards the 1.2800-1.3000 area

Markets are off to a positive start in the early week, with two key developments over the weekend seen as the primary drivers for the initial surge in risk correlated assets. The news that EU assistance to the Spanish banking sector in the amount of Eur100B has well exceeded estimates of most analysts, while Chinese data was not as bad as many had feared. Both of these developments have resulted in a market rally driven by the expectation that the global economy will continue to be supported by proponomics.

Every time we see evidence of governments in a position to pump more money into the system to keep things from falling apart, market participants take it as a sign that things will never fall apart given what seems to be a global coordinated effort to prop the financial system. In Spain, more money will now be allocated to help alleviate the stresses in the banking sector, while in China, a combination of only slightly softer data coupled with contained inflation readings, gives further ammunition to the PBOC to apply additional accommodation to monetary policy. Investors therefore feel comforted by the fact that their governments will continue to keep things as easy as possible even at the risk of longer-term threats.

Perhaps the success that we have see from this strategy out of the US offers additional comfort with this approach, as there have been clear signs of recovery within the US economy throughout this period of ultra-accommodative monetary policy and quantitative easing. At the same time, we also would remind investors that the overriding trend in the market is still risk negative and the rebound that we are seeing can also be attributed to some necessary corrective price action following some intense moves in recent weeks. We contend that this is ultimately the more likely scenario and as such, we would be looking for opportunities to sell risk rallies when the Euro trades into the 1.2800-1.3000 area.

Euro – Is this the Recovery or the Calm before the Storm?

The Euro bounced sharply off of multi-year lows in a week of impressive recovery for the US S&P 500 and broader financial markets. Yet a fresh wave of downgrades and generally sour news out of the Euro Area meant that the EUR ended only modestly higher against the safe-haven US Dollar. What can we expect in the week ahead?

The first full week of the month has produced an important bounce for the Euro against the US Dollar, but it may take a material improvement in European market sentiment to force a larger EURUSD rally. A relatively empty week for European economic event risk leaves market focus squarely on developments in European fiscal crises.

European Central Bank President Mario Draghi could partly be blamed for stoking market tensions as the ECB made it clear that there was little the central bank could or would do to further help Spain and other countries in the midst of clear fiscal crises. The ECB has already taken significant steps to ease market tensions, but it is ultimately a political problem that will require political change—not monetary policy easing. That said, several members voted in favor of an interest rate cut and there’s reason to believe this sets the stage for a move at their upcoming meeting. Lower interest rates could in fact ameliorate financial market tensions but are less likely to help the Euro itself.

Spain otherwise continued dominating headlines, and the next developments for the at-risk government and banking system will likely drive sentiment in the week ahead. Fitch Ratings downgraded the Kingdom of Spain’s long-term debt rating by a three notches to BBB with “Negative” outlook. The downgrade itself didn’t come as a major surprise, but the severity of the downgrade and the fact that it is just two notches above “Junk” territory hung heavy on Spanish bonds. If Moody’s Ratings Agency becomes the third major agency to downgrade Spain (alongside Fitch and Standard & Poor’s) to the BBB level, banks using government bonds as collateral at the ECB will be required to post an additional 5% in capital to secure existing and new loans.

Spanish banks are perhaps the biggest risk to the central government and—by extension—to Euro Zone financial stability through the foreseeable future. An additional collateral requirement at the ECB would put further pressure on bank balance sheets at exactly the wrong time as the country’s fourth-largest lender was just nationalized due to outsized losses. The Center for European Policy Studies estimates that Spanish banks may face €270 billion in funding needs—a sum that would represent over a quarter of Spanish Gross Domestic Product. Spain’s government is currently facing significant difficulty as it funds bond redemptions and an estimated 2012 deficit worth another 8.5 percent of GDP. Add another 25+ percent and debt could quite easily spiral out of control.

The dangers to the Euro Zone are clear, but whether or not the Euro presses to fresh lows is another matter entirely. Many speculate that a bailout package for Spain is imminent and indeed inevitable. Will this be enough to save the Euro? In this author’s opinion, that is very unlikely. It all seems like a case of déjà vu as the Euro feels the pain from remarkably unequal growth and productivity levels within Euro countries. It seems like the best strategy may be to sell major rallies within the clear downtrend dating back to 2008. – DR

Dollar Pauses as Market Awaits Another Wave of Crisis or Stimulus

After five-week rally, the US dollar finally closed in the red this past week. Yet, looking at the fundamentals behind this capitulation, we are looking at a shift to consolidation rather than an immediate reversal. To dramatically turn the tables on the greenback, we must shift the fundamental bearings on sentiment – and that is exceptionally difficult to do given the underlying trends before us. From a big picture perspective, we have slowing growth, spreading financial tensions and fading yields. Basically, we are seeing lower rates of return against growing risks. This is not a mix that naturally spurs risk taking. What we need is a catalyst to tip the scales between risk and reward, and the coming week’s docket may not carry the necessary weight to tear attention away from the future Fed rate decision.

When there is a heavy piece of event risk in the foreseeable future – one that can dramatically alter the landscape of the markets – investors are oftentimes encouraged to stick to the sidelines rather than take risk on meaningful risk and find themselves on the wrong side of a momentous trend change. A common example I use is the lead up to the monthly NFPs release. Though the employment data is not guaranteed to rouse a new trend, the markets typically retrench in the preceding 24-48 hours of the release to respect the volatility that could results.

In the week after next, we have a dramatic round of extremely important events penciled into the calendar. Rather than look at basic risk versus reward, we are now looking at revived financial crisis versus hope for stimulus (inherently a troubled and temporary equilibrium, but that is a topic for another time). And, to that point, much larger seismic events are required to tap such deep wells. Beyond the upcoming week, we have big-ticket items like the second Greek election, the G-20 meeting, the EU Summit and the Fed’s rate decision (equipped with updated growth, inflation and interest rate forecasts). Each of these could carry the day on extreme fear (financial situation is melting down and/or no stimulus is coming) or an opportunity for speculators to jump in on depressed buying opportunities (crisis is averted and/or heavy-handed central bank investment is coming down the line).

Between this end of this past week and that imperious wave of fundamental risk, we have meaningful event risk but perhaps not the level of fodder that can distract the masses from their longer-term view. The immediate first line of interest is the rumored meeting between Spain and European officials. The Budget Minister already called for external support of the country’s troubled banking system, but they are expected to make it official. The bounce from equities and the euro (and subsequent slide from the dollar) into the end of the week reflects expectations that this will go through without hitch. As such, if it is denied (perhaps in a dispute over a full bailout and one just for the banking sector) or comes in smaller than what the market deems is necessary, we could find an early swell in fear that dominates the first half of the week. Alternatively, the Euro Zone’s troubles run deep, so stabilizing Spain may not rouse much confidence with Greece ahead.

Through the rest of the week, we should keep tabs on the ebb and flow of risk trends. We can monitor that specifically through the performance of the dollar (an extreme safe haven through its liquidity properties), the S&P 500 (particularly adept at playing to stimulus hopes) and the general strength of correlations across the different markets (it takes a heavy wind to sync such dramatically different assets). From the Dollar’s docket, we have a number of central bank speeches penciled in; but they won’t carry much weight before the Fed rate decision. As for data, the retail sales and CPI data will speak to the growth and inflation balance they look to strike, but we won’t be turning the titanic this late in the game. We should keep an eye on the TIC data though to measure USD safety demand. –JK