Euro Treads Water As Focus Remains On Spanish And Italian Yields

Sentiments was lifted by revived QE3 hope on Chicago Fed Evans' comments yesterday, as well as ECB's support on European Commission's banking union proposal. The Dow rose 162 pts overnight and was followed by a broad based rebound in Asian equities. Nonetheless, strength of the risk rebound is so far very limited. European majors are also staying soft against dollar and yen even though there is no fresh selling yet. It should be noted that Evans is the most dovish Fed official and thus his comments should be discounted. And, markets are still in deep worry in the situation in eurozone as Greece will have elections this Sunday, Spanish and Italian bond yields kept climbing.

In its bi-annual Financial Stability Review, ECB urged that it's now necessary to go beyond monetary union and conceive a "banking union" as an integral part. Three important objectives were identified including banking sector supervision, a European deposit guarantee scheme and contribution of financial industrial towards stability. ECB emphasized the need to tackle the "root causes" of the debt crisis and urged comprehensive response from officials to end "a spiral of systemic risk augmentations." Nonetheless, ECB also noted key risks to financial stability including aggregation of debt crisis, lower bank profitability on weak economy and excessive pace of deleveraging.

Investors are still clearly nervous on Europe's situation, in particular in Spain, Italy and of course Greece. The benchmark 10-year Spanish yield jumped to record 6.72% yesterday, comparing to just 6.24% before the news of the EUR 100b bank bailout plan. Some sell-off was seen in Spanish bonds after Fitch downgraded 18 Spanish banks, citing the country’s economy would weaken further and would have a negative effect on business volumes "which, together with low interest rates, will place pressure on revenues." Focus remains on how fast Spanish yield would jump to the 7% unsustainable level which eventually lead to country bailout of Greece, Ireland and Portugal. Italian 10-year yields also continued to stay above 6% and was at 6.16% yesterday highest level since January.

Italy will try to sell as much as EUR 4.5b of fixed rate bonds tomorrow and that would be a test on investor confidence. While emphasizing that Italy has no need for external assistance, prime minister Monti said in a statement yesterday that he's "worried by the situation of emergency" on the financial markets. He called for cohesion among political parties to "overcome the critical situation and give an image of unity abroad."

A US independent rating agency, Egan-Jones warned that Spain and Italy could need a full-scale bailout within six months. Founding Partner and President Sean Egan said that "it makes little sense to separate the banks’ credit quality from the governments’ credit quality." He predicted that Spain will be "back at the table" and ask for more than the EUR 100b they sought. Meanwhile, Egan also noted that the combined economies in EU have fairly high debt-to-GDP, and the assumption that Germany will be able to pull may need to be "re-examined."

In the US, while the Fed Chairman Ben Bernanke had tried to downplay the need of further easing recently, Chicago Fed President Charles Evans showed his supports on further stimulus to bolster the job market. He stated that he’s been "in favor of pretty much any accommodative policy." For instance, he believed that "extending the Twist would be useful," "more asset purchases would be useful" while "more mortgage-backed securities purchases would be good." His comments have again raised hopes of additional unconventional measures by the Fed after operation twist expires at the end of this month.

RBA Governor Glenn Stevens said the Australian dollar's exchange rate is "pretty high" but "we shouldn't wish too quickly for a low exchange rate." He noted that some sectors are struggling with the exchange rate and there presents a test on how enterprises can "get the productivity up." But he noted there are big benefits to consumers. Also, he predicted that Aussie's strength is there to continue as mining investment boom intensifies. This is somewhat seen by market as an endorsement of the high aussie. meanwhile, Moody's affirmed Australia's AAA rating with stable outlook. Moody's noted that "economic strength is classified in Moody’s rating methodology as very high, based on the country’s economic diversity, the performance of the economy during the past two decades, relatively good growth prospects and high per capita income."

On the data front, Germany CPI, eurozone industrial production, Swiss PPI, US PPI, retail sales and business inventories will be released later today.