Spain and Cyprus Situations Deteriorate amid Contagion of Eurozone Crisis

By Roger Baettig | June 26 2012 4:21 AM

The turmoil in the Eurozone has made no signs of stabilization after formation of a new government in Greece. In fact, the market focus has recently turned to Spain, Italy and even Cyprus, indicating the contagious impact of the sovereign debt crisis in the region. Investors have obviously lost hopes that any game-changing outcome will be announced after the EU summit later this week, sending financial markets lower. Wall Street declined with the DJIA and the S&P 500 Indices losing -1.09% and -1.60% respectively. In the commodity sector, the bounce in oil prices proved to be short-lived as Tropical Storm Debby weakened and moved away from key producing areas in the Gulf of Mexico. Weakness in sentiment also dampened prices. The front-month contract for WTI crude oil, closing at 79.21, slipped -0.69% while the equivalent Brent crude contract ended the day largely unchanged at 91.01 after briefly breaking 90 again. Gold rebounded during the day with the benchmark Comex contract gaining +1.37% as the metal regained some of the safe haven quality.

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Ahead of the EU summit on June 28-29, German's Chancellor Merkel said that Euro bonds, Euro bills and European deposit insurance with joint liability and much more was economically wrong and counterproductive. Moreover, she openly stated that the upcoming summit will be far too much about all kinds of ideas for joint liability and far too little about improved oversight and structural measures....So the goal has to be a political union in which the standard is whatever the best, not mediocrity is. These comments suggested that Merkel continued to oppose the ideas of joint Euro bonds. While this does not mean that she will not accept such as move even though the market situation deteriorates markedly further, the terms and conditions of any joint issuance would likely be under Germany's ruling.

Shortly after Spain's formal request for bailing out its banking sector, Moody's reduced long-term debt and deposit ratings for 28 Spanish banks and two issuer ratings. According to the rating agency, these banks have a link to Spain's creditworthiness which has deteriorated and will affect the credit profile for Spanish banks. The move followed Moody's downgrade of 16 Spanish banks in May. Meanwhile, it's reported that Cyprus has asked for financial assistance from the EU/IMF to save its banks, making it the firth country in the bloc that needed bailout. Yet, the amount and terms will still need negotiation in coming days. It's expected that the required fund will range from 5-10B euro, compared with 100B euro required by Spain.

On the dataflow, Germany's Gfk consumer sentiment probably slipped -0.1 point to 5.6 in July. In the US, consumer confidence might have dropped -0.9 points to 64 in June while S&P/Case-Shiller composite-20 index might have contracted -2.05 y/y in April after a -2.6% drop in the prior month.