Optimism Evaporated as Bailout Unable to Resolve Crisis. Worries over Capital Control Raised

By Roger Baettig | June 12 2012 3:52 AM

Market sentiment buoyed by Spanish bailout turned out to be short-lived as investors realized that the sovereign debt crisis in the Eurozone would not be resolved only with the financial assistance. The market was disappointed as Atlanta Fed President Lockhart stated that he was not quite convinced that current circumstances call for additional action. As hopes of QE3 were downplayed further, the greenback was sent higher. In the commodity sector, the front-month contract for WTI crude oil initially soared to as high as 86.64 before ending the day at 82.70, down -1.67%, while the equivalent contract for Brent crude rose to102.21 before settling at 98.00, down -1.48%. The benchmark contract for gold closed below 1600 for a third consecutive day as hopes of the Fed's easing lowered.

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Optimism over the Eurozone situation was over as the market well understood that the Spanish bailout is just a temporary pain killer but not a solution of the debt problems. As not much detail was unveiled over the weekend, the market began to speculate how the debt-ridden Spain would be financed. There have been speculations on whether the bailout will be financed by the ESM or EFSF. An 'EU official' suggested that the EFSF was preferred to avoid the ESM's preferred creditor problem while a spokesperson for the German Finance Minister said that the ESM was more likely to be chosen. Market sentiment was damped also by reports that EU leaders have been in discussion about the possibility of using capital controls in the case of a Greek exit from the Eurozone. Rumors said that limits of ATM withdrawals and border checks were considered.

Atlanta Fed President Lockhart stated in a speech in Chicago that no options should be taken off the table under the current circumstances and he was convinced at this moment that the circumstances quite yet call for additional action. On the growth outlook, Lockhart forecast the recovery process to be slow and drawn out. He believed the growth outlook would moderate, with a slow and possibly halting decline of unemployment, with inflation staying close to 2%.

On the dataflow, the UK would release its industrial and manufacturing production in April. Although improvements are anticipated, growth would probably be modest. Manufacturing production is expected to have climbed +0.4% y/y in April after a -0.9% slip in March while industrial production probably dipped -0.9% y/y after contracting -2.6% a month ago.