Spain has pledged the rescue of Bankia, its third-largest lender by assets, but only has about €9 billion left in its bailout fund versus the required €19 billion. EUR/USD has fallen more than 0.3% to 1.2455 from 1.2501 at the end of trading in New York, its lowest price since July 2010.
There was a divergence overnight between the performance of stocks and beta currencies. Most stock markets in the US and Europe closed higher, whereas the dollar was the biggest winner in the FX market. EUR-USD smashed through 1.2500 quite easily on the ratings downgrade of Spain by Egan-Jones from BB- to B. In fact, given the weak economic data from the US overnight and the negative headlines out of Europe it is surprising equity markets were able to climb higher.
The Financial Times reported that the ECB had rejected Spain's plan to finance the recapitalisation of its banking sector, which is creating even less demand for Spanish paper. There were also reports that Bank of Spain Governor Ordonez will leave his post one month early. Overall, the situation in Spain has the possibility of deteriorating significantly which is weighing on investor sentiment, in particular EUR, and creates the risk of more EURUSD downside towards 1.2300.
Furthermore, investors are reeling from the news that China will not be pursuing stimulus plans like those of 2009. Whilst this doesn't come as a great surprise to the market its raises some lingering concerns about the exact magnitude of Beijing's policy loosening plans. We expect the government to reduce the RRR a few more time this year and possibly even cut interest rates, but these alone are unlikely to spur growth enough, especially considering the headwinds faced by Europe. Instead, we want to see more aggressive action from the Chinese government before it is too late. Generally, we still think the government has both the will and ability to undertake more aggressive policy easing, but we there are still lingering concerns.
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