Dollar Jumped On Spain Worries, But Losing Steam On Revived QE3 Talk?

Worries on Spain's banking system and weak global economic data somewhat took over the Greece exit concerns last week as the main risk aversion driving force. Spanish 10-year yield reached 6.7% and got itself closer and closer to the unsustainable 7% level which eventually led to bailout of Greece, Ireland and Portugal. European majors remained broadly pressured over the week. And indeed, latest CFTC data showed net euro shorts jumped to record high of 203k contracts in the week ended May 29, comparing to 195k contracts in the prior week. Weakness in European majors will likely continue.

Global equity markets were also under tremendous pressure on European debt crisis and weak economic data. The Dow ended the week at 12118, -336 pts lower or -2.7%. DAX closed at 6050, down -289 pts or -4.5%. Nikkei closed at 8440, down -140 pts or -1.6%. The CRB commodity index closed at 268.31, down -13.6 pts, or -4.8%. On this backdrop, aussie and loonie were both pressured against dollar and yen. But so far, they remained relatively resilient against European majors.

Meanwhile, an important development to note is that the dismal nonfarm payroll report from US put some pressure on dollar on Friday. While the Dow was deeply sold off after the NFP release, the dollar has indeed pull backed against euro, sterling, swissie, and even aussie. USD/JPY was hit hard as the poor employment data drove speculation of QE3 from Fed and sent US 30 years yield to close at record low of 2.540% while 10 year yield also closed at record low at 1.467%. Sharp fall in US yields and has, in turn, gave the Japanese yen a strong boost across the board with EUR/JPY making a 12-year low. The revival of QE3 talk can also be seen in gold, which rebounded over 4% on Friday alone and is back at 1627 level comparing to May's low of 1526.

So the overall picture is that European majors will remain pressured as the debt crisis won't be resolved soon, at least not until there is some clear resolution in Spain's banking sector. It looks like the selloff in risk markets will continue further and thus, commodity currencies won't have any luck. The dollar should continue to benefit from risk aversion as that's the overall trend. But the road ahead for dollar could start get bumpy on revival on QE3 speculations. That leaves yen as the preferred currency to go long in the near-term, until intervention comes back.

To summarize the situation in eurozone, there is no clear communication on how Spain is going to fund the EUR 19b bailout of Bankia yet and EU officials is starting to impatient on it. Rumors of Spain's talk with ECB and IMF was rejected and ECB has stated clear of its opposition if Spain inject government bonds to Bankia to be used as collateral for ECB loans. Situation somewhat worsened further as Bankia said on Saturday that it will delay payment of EUR 61.3m of interest on subordinated debt and preference shares. It's getting more and more likely that Spain will need to get external help from EU, in particular as its government bond yields continue to surge.

In Greece, opinion polls were mixed with Some showing Syriza leads while some showed New Democracy leads. We'd likely to emphasize again that even after the June 17 election, the could still be no resolution to the political struggles. That is, the result could just be as indecisive as the May election. And thus, Greece exits or does not exit? Highly uncertain. A piece of better news is that EUR's fiscal treaty won in a decisive manner in Ireland's referendum with final results showing 60.3% voted in favor. That should be a boost to Germany, which has been push for fiscal discipline across EU.

On the economic data front, US nonfarm payroll showed merely 69k job growth in May, much less than expectation of 150k. That's also the worse number in a year. April's figure was also revised down from 115k to 77k. Unemployment rate edged up to 8.2%. US ISM non-manufacturing index unexpectedly dropped to 53.5 in May. Note that the price paid component dived to contraction region at 47.5, first since last December. UK PMI manufacturing dived from 50.2 to 45.9 in May, lowest level since May 2009. Also, that's the second steepest fall in two years. The data showed sharp deterioration is seen in UK manufacturing sector ahead and steep contraction could be seen. Eurozone PMI manufacturing was revised slightly up to 45.1 in May, but stayed fall below 50. Swiss SVME PMI unexpectedly dropped to 45.4 in May, lowest since July 2009.

In China, the official manufacturing PMI dropped sharply from 53.3 to 50.4 in May while the HSBC manufacturing PMI was also revised down to 48.4. There has been talk of another stimulus program that's over USD 300b from China, nearly half of the 2008 stimulus package. But the official Xinhua News Agency later stated that the intention of Chinese government is "very clear" and it will "not roll out another massive stimulus plan to seek high economic growth." That is, “the current efforts for stabilizing growth will not repeat the old way of three years ago." Some Chinese analysts noted that China's stimulus program will be small, and modest at best.