Tension in Spain Sends EUR to 2 Week Lows

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Market Drivers September 26, 2012
Markets remain on edge after Spanish protests turn violent, yields inch back to 6%
Italian bill auction goes well, lowest yield since March
Nikkei -2.03% Europe -1.61%
Oil $90.63/bbl
Gold $1765/oz.

Europe and Asia:
NZD Trade Balance -789M vs. -619M
EUR German Consumer Price Index 0.0%

North America:
USD New Home Sales 10:00

Currency markets remained tense in the wake of demonstrations in Spain that turned violent sending EUR/USD to a two week low of 1.2850 in early morning European trade. Yesterday’s demonstrations in front of Parliament in Madrid along with calls for an early election in Catalonia, one of Spain’s most important economic regions, have clearly shaken investor confidence putting pressure on the euro over the past 24 hours.

As officials struggle with restoring order the fixed income markets were under stress as well with yield on the benchmark Spanish 10 year bonds inching back towards the 6% level. Tomorrow the Spanish government is expected to present its budget, with investors looking to see if the government will implement any of the reforms recommended by the EU commission.

So far Prime Minister Rajoy has resisted efforts to formally request a bailout from EU, hoping that the OMT program by the ECB would lower the cost of financing for the country without the need of additional European aid. However, events on the ground are clearly disrupting his best laid plans and Mr. Rajoy may have no choice but to turn to the bailout route if the protests grow in size and scope, sending further tremors through the financial markets.

On the bright side Italy was able to auction off T-bills at 1.5035% versus 1.585% rate – its lowest yield since March as fixed income markets are starting to see some divergence between Club Med economies. However, we don’t believe that this dynamic will last. If Spain begins to come under serious duress, Italy is very likely to follow as the demand in both economies remains lackluster and fiscal finances are exceedingly fragile.

The euro therefore could remain under pressure for the rest of the day unless the political situation on the ground begins to calm down. The currency market is back to watching sovereign debt spreads with German-Spanish differential back to stress levels above 450 basis points. If tensions do not ease both on the streets of Madrid and on the screens of bond traders the EURUSD could slide towards 1.2800 as the day proceeds.

Boris Schlossberg
Managing Director

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