Markets fall on Spain's banking woes

Wed, May 30, 2012, 01:00

European shares fell and the euro neared a two-year low today, depressed by worries that Spain's banking problems would push its borrowing costs to unsustainable levels and force it to seek a bailout.

US stocks opened lower day as rising bond yields for Italy and Spain and the latest poll results in Greece worsened fears about a spiralling of the euro zone's debt crisis.

The Dow Jones industrial average was down 110.46 points, or 0.88 percent, at 12,470.23. The Standard & Poor's 500 Index was down 11.81 points, or 0.89 per cent, at 1,320.61. The Nasdaq Composite Index was down 28.75 points, or 1 per cent, at 2,842.24.

Spain's central bank governor, who is stepping down early in a storm over banking woes that have pushed borrowing costs near the unsustainable 7 per cent level, said the government would miss its deficit target this year.

"The Spanish banking crisis has the potential to knock the stuffing out of the euro zone irrespective of the Greek election results," said Jane Foley, senior currency strategist at Rabobank. The Greek vote on June 17th has raised concern the country could reject its bailout deal and leave the euro zone.

The single currency was down around half a per cent to $1.2433, its lowest since early July 2010. It also lost more than 1 per cent against the safe-haven yen, taking it to a four-month low of 98.274 yen.

The euro's plight underpinned the dollar index, measured against a basket of major currencies, which rose above 82.73 to its highest since September 2010, dragging down dollar-sensitive commodities.

The pressure on the single currency and other European asset markets gained a brief respite when the European Commission, the executive arm of the European Union, said the euro area should move towards direct recapitalisation of banks using its permanent bailout fund.

It also called for the region to move towards a full banking union and consider issuing euro bonds - all measures that could ease the crises in peripheral European nations but would face strong opposition from some member states, including Germany.

"We will sell into this bounce as these proposals will take a long time and will entail changes to the treaty," said Geoffrey Yu, currency strategist at UBS, referring to the agreement that created economic and monetary union.

The calls from the EU did help pull Spanish government bond yields back from their highs but the 10-year bond yield was still up 18 basis points on the day to 6.66 per cent, and the cost of insuring against a Spanish default also rose.

The sell-off in Spanish bonds has also kept the risk premium or spread over safe-haven German government bonds (Bunds) at a euro-era high of 533 basis points.

"The more the yields are rising, the more the probability goes up that in the end Spain has to ask for support from the IMF or the ESM (Europe's bailout fund)," said Joerg Kraemer, chief economist at Commerzbank.

"I would say there's currently a 50 per cent chance the Spanish government will ask for official support."

German 10-year yields meanwhile hit fresh lows of 1.31 per cent today, while futures prices rallied 37 ticks higher on the day at 144.93.

Unnerved by the deepening financial crunch in Spain, investors also pushed Italy's funding costs sharply higher at a bond sale, with 10-year yields topping 6 per cent for the first time this year.

Major European company shares suffered in line with the euro on the Spanish bank jitters but resource-linked stocks were also affected by disappointment over signals that any Chinese stimulus package was likely to be more modest than expected.

The FTSE Eurofirst index of top European shares reversed all of yesterday's gains to be down 0.7 per cent at 983.92 points and is on track for its third straight month of losses.

World equity markets had been focused on hopes China would boost its flagging economy with new spending measures but these were dampened today by reports in the domestic media.

An article published on the website of the official Xinhua news agency said China had no plan to repeat the powerful stimulus measures used during the global crisis in 2008. The story was in line with the view of Chinese policy advisers.

The reports undermined sentiment across Asian markets, and helped send the MSCI world equity index down 0.5 per cent 302.31, while the MSCI emerging markets index fell 1 per cent at 911.58.

May looks set to be the worst month for the global share index since September last year when the euro zone crisis was also driving investors away from riskier assets.

In commodity markets, Europe's debt problems, the limited scale of any Chinese stimulus and the stronger dollar put prices under pressure. A strong dollar makes commodities priced in the US unit more expensive for holders of other currencies.

Copper trading on the London Metal Exchange was down 1.7 per cent to $7,540 a tonne and is down more than 10 per cent so far this month, heading for its biggest monthly fall since September 2011.

The potential for slower global growth also sent Brent crude down $1.73 to $105 per barrel and on course for its biggest monthly decline in two years. US crude was down $1.07 at $89.69.Oil's fall could be checked by supply concerns as Iran's dispute with the West over Tehran's nuclear program is unresolved.