EUROPEAN MARKET INSIGHT
The European summit meeting on June 29 and the subsequent euphoria waxed and waned very quickly in what is now becoming a relatively predictable pattern across the Atlantic.
Last week continued the denouement as Spain was the ultimate loser amid growing worries about its banking sector and autonomous regions.
The euro common currency lost 0.76 percent last week, closing at $1.2156 last Friday. European stocks lost all of their gains and then some at the end of the week as the Dow Jones Euro Stoxx equity index slid to 2,237 points, losing 0.96 percent for the week. Spain’s IBEX index was down 5.8 percent on Friday alone, losing 6.26 percent for the week.
Economic Data in Spain Deteriorates as Egan Jones Downgrades
As 10-year bond yields shot to over 7 percent and spreads over the equivalent German benchmark bond reached new records, new worrying data is coming out of Spain.
The two sectors that only a few years ago propelled the Spanish economic “miracle” are now suffering the worst. The banking sector had to report a 14th consecutive increase in bad loans according to the Bank of Spain. Bank deposits declined another 5.75 percent year-on-year, a sign that common people are losing trust in their banking system.
The other cornerstone of the Spanish boom, the real-estate sector, registered the fastest decline in house prices since the start of the eurozone crisis during the second quarter.
This economic decline has not been lost on the rating agency Egan-Jones already for some time, but the independent provider of credit ratings took this opportunity to further reduce the rating on the Kingdom of Spain to CC+: “Spain’s 10-year debt is now yielding 7.18 percent, which is a reflection of the weakening of the economy and the credit quality of Spain. In addition to the expected austerity riots, the latest news is that Valencia and other regions will need $15B of aid” reads the official release of the rating action.
IMF Does Not Expect Swift Recovery
The International Monetary Fund (IMF) is also concerned about Spain. In its recently published “Fiscal Monitor,” the international institution does not see Spanish debt ratios improving until at least 2016, too late for its ailing banking and real estate sector.
Part of the reason for this assessment might have to do with the recent avalanche of requests for federal support from as many as six autonomous Spanish regions. Spain has created an 18 billion euro ($21.88 billion) fund to support regions such as Catalunya or Valencia, which are shut out of the public debt markets.
According to an article in the German daily FAZ, “Spain has no plan B” and it might be out of money as soon as September.
This is in spite of the fact that a direct bailout of Spanish banks was approved by European Union (EU) finance ministers at 100 billion euro ($121 billion), last Friday. Analysts at J.P. Morgan had previously estimated the funding needs to be more in the region of $180 billion.
Lack of Credibility Reason for Sell-Off
Despite the seemingly good news of the approved bank bailout, the market sell-off signals that traders and investors do not believe that the initiative by the EU will work.
Politicians in the eurozone have continuously eroded confidence in their institutions, as practically none of the previously promised measures by individual governments in Greece, Spain, and Italy were implemented. In addition, none of the so-called “rescue mechanisms,” such as the European Financial Stability Fund and the still-not-operational European Stability Mechanism, did what their names implied and provided some sort of stability for investors to work with.
Instead, the markets look to global central banks for help, yet the European Central Bank two weeks ago and the Federal Reserve this week did not comply and neither central bank announced large-scale asset purchases, something the market was looking for. Traders most likely waited for Bernanke’s testimony last Wednesday before frantically hitting the sell button toward the end of the week.
The Week Ahead
The ECB will publish a lending survey of lending standards across the eurozone. If standards tighten further, this might give the bank more room to implement larger asset purchases to juice the markets.
The eurozone will release first-quarter government debt figures, a very important number that will show how peripheral nations are doing in terms of the reduction in deficit spending.
The manufacturing PMI will shed further light on where the economy is going, but despite the low estimates, it is unlikely to provide a turning point in sentiment.
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