The rain in Spain falls mainly on... global risk appetite!

“No man is happy but by comparison” – Thomas Shadwell

Spain vs.Greece?
Far from drawing analogies to Greece in the current environment I feel that it is much more pertinent to focus on the differences between Spain and their southern Eurozone counterparts at the current juncture. Firstly it was heavily argued that it was fiscal profligacy that was the root cause of the Greek fiscal instability. In Spain however the entry into the Eurozone was coincident with a period of low debt and a budget surplus; the current fiscal woes are a result of an enormous housing bubble that caused huge economic ramifications (it was arguably the lower rates and easier credit provided by the Eurozone construct itself that fuelled the bubble). With a different cause to the troubles it could be argued that a different cure is more apt.

Despite some moderately positive economic data from the US yesterday, Spanish 10-year yields pushed above 6.0 percent and equities continued to slide as the concerns that the economic ills of one of the Eurozone's largest economies will lead to an unsustainable level of sovereign debt yields and the unknown ramifications that would ensue, became, to a certain degree, self-fulfilling. The notion, as espoused by the Spanish Prime Minister himself that “It is not possible to rescue Spain” (inferring that Eurozone bailout funds would not stretch to the magnitude required for the larger peripheral nations, not that Spain is beyond help!). This is a key difference between the two situations.

So where does this leave the global economy and financial markets?
As I see it the developing dynamic is one that will exaggerate the economic and growth differentials between the Eurozone and the rest of the world, broadly along the lines of my suggestions on Friday. Spain has been open in admitting that it has never grown in times of fiscal deficits and the economic motivation for the required fiscal austerity is becoming increasingly called into question. However at the current juncture and unless there is a significant and sustained deterioration in global economic sentiment and confidence then I continue to see the current issue as further sapping the strength from a weak Eurozone recovery, but ultimately not derailing the rest of the world.

Austerity in Spain may well be the wrong cure, however the global economy should continue to be supported by global ‘easy money’ and with China, Japan, Sweden and Australia all easing further in a positive world (and many more including the US, UK, and Eurozone in a less friendly world) the backdrop should continue to remain supportive for risk.

My central scenario is that there is a global accord to increase the non-Eurozone International Monetary Fund contributions at the G20 this weekend (although from news overnight that Japan will commit USD 60 billion adds to the view that the total may be less than the hoped USD 500 billion) and this will likely arrest the rapid rise of Spanish yields, however, the rising economic differentiation between the Eurozone and the rest of the world will continue to be a growing theme. The real danger between now and the weekend is that volatility picks up to a large enough degree to trigger out core strategic positions at the wrong levels.

Overnight the RBA minutes from the April 3^rd monetary policy meeting confirmed the sentiment from Governor Stephens earlier in the month that growth is now considered to be below trend, and not as previously thought ‘at’ trend.  The interest rate market had however already priced in two rate cuts over the next quarter and as such the direct connotation of the minutes was minimal.

Data, what data?
Whilst there is the German ZEW survey today, along with UK CPI and even the Bank of England minutes from the April Monetary Policy Committee meeting tomorrow, the main focus and driver of markets in terms of the current dynamic will likely be the Spanish Bond auction on Thursday. Decent demand at the auction will likely calm market nerves and see a resurgence in equities and risk assets. Weak demand could see a sharper and more protracted down move in the EUR, equities and risk assets.