EURUSD DAILY

Much volatility was seen in the markets last week as talk of additional easing from Fed, as well as rate cuts from China and RBA, boosted risk markets and pressured dollar. The hope for QE3 was then dashed as Bernanke failed to deliver in his testimony with lack of hints on QE3. Then towards the end, risk markets was then lifted again by talk of imminent agreement of bailout for Spain's banking sector. At the time of writing, there was no announcement made regarding the bailout yet. But there should be some news after the EU finance minister conference call at 4pm Brussels time. Risk rebound could extend further initial this week. But we'd like to point out that such rebound might not be sustainable since traders would remain cautious just ahead of Greece election next Sunday on June 17.

Spain did had a decent bond auction last week even though yields jumped in the auction. It's believed that Fitch's downgrade of Spain by three notches was the trigger for the rush for talk on bailout on Spain's troubled banks. EFSF, the temporary bailout fund, is expected to be involved. A solution is for EFSF to inject bonds into Spanish banks which could then be used as collateral to access ECB liquidity. Such a program would be fundamentally different from bailout of Greece, Ireland and Portugal as it's directly addressing the banking sector, not the government. Thus, additional austerity measures for the Spanish government would not be a pre-condition for the aid. In any case, we'll keep an eye on the development over the weekend.

Last week, Fitch downgraded the credit rating of Spain by 3 notches to BBB. The rating agency cited that "the negative outlook primarily reflects the risks associated with a further worsening of the Eurozone crisis, notably contagion from the ongoing Greek crisis". Fitch warned that the costs of restructuring and recapitalizing Spanish banking sector is at around EUR 60b and could be as high as EUR 100b in a more "severe stress scenario". That's more than double of it's original forecast of EUR 30b. However, the "reduced financing flexibility" of Madrid will constrain its ability to intervene in the restructuring and raise the odds of "external financing support". And, Fitch noted that Spain's gross public debt could peak at around 95% of GDP in 2015. Regarding the economy, Fitch expected Spain to say in recession throughout this year and 2013, and that's a downgraded outlook from expectation of mild recovery in 2013.

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