Risk Rebound Lost Steam After Bernanke Disappointment, Fitch Downgraded

Risk rally seemed to have lost much momentum as investors were disappointed by Fed Chairman Bernanke's lack of signal on adding monetary stimulus overnight is his testimony to congress. In addition, Fitch's downgrade of Spain's credit rating also remained investors of the ongoing sovereign and banking crisis in Eurozone. The boost from China's first rate cut in three years was rather brief. DOW ended the day up merely 46 pts at 12460, after jumping to as high as 12555 during initial trading. Meanwhile, Asian equities are all in red. In the currency markets, major currencies are showing sign of reversal against dollar and yen and we'd probably see more upside in the latter two before the week closes.

At the testimony, Fed Chairman Bernanke stated that "the situation in Europe poses significant risks to the US financial system and economy and must be monitored closely". He also indicated that "the Federal Reserve remains prepared to take action as needed to protect the US financial system and economy" due to the risks posed by "the situation in Europe". Regarding further easing by the Fed to boost the US growth, the Chairman stressed the Committee has a number of options to consider and if it's decided that "further action is required", the Committee would also "decide what action is appropriate or what communications are appropriate". Yet, he did not indicate what options are being considered. That's somewhat in sharp contrast to Vice Chairman Yellen's urge for additional accommodation the day before, as she said it's "appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest".

The situation in the Eurozone remained worrisome. Fitch's downgraded the credit rating of Spain by 3 notches to BBB. The rating agency cited that "the negative outlook primarily reflects the risks associated with a further worsening of the Eurozone crisis, notably contagion from the ongoing Greek crisis". Fitch warned that the costs of restructuring and recapitalizing Spanish banking sector is at around EUR 60b and could be as high as EUR 100b in a more "severe stress scenario". That's more than double of it's original forecast of EUR 30b. However, the "reduced financing flexibility" of Madrid will constrain its ability to intervene in the restructuring and raise the odds of "external financing support". And, Fitch noted that Spain's gross public debt could peak at around 95% of GDP in 2015. Regarding the economy, Fitch expected Spain to say in recession throughout this year and 2013, and that's a downgraded outlook from expectation of mild recovery in 2013.

Yesterday, ECB left the main refinancing rate unchanged at 1% although sovereign debt crisis in the Eurozone intensified. At the press conference, President Draghi unveiled that the decision was made by consensus and indicated "a few members" favored further rate cut. Yet, Draghi also downplayed the effectiveness of additional easing to the economic and financial environment. More in ECB Left Interest Rates Unchanged, Draghi Questioned the Effectiveness of Monetary Policies on Crisis.

Also, the People's Bank of China (PBOC) lowered the 1-year lending and deposit rates by -25 bps, effective June 8. This first rate cut since December 2008 came in with great surprise as the government adopted 'asymmetric' rate change. Slowdown in Chinese economic growth and deterioration in the global environment in recent months have triggered speculations of a reduction in lending rate for some time. However, a cut also in the deposit rate was rather unexpected. Moreover, the PBOC's raise of the ceiling on the deposit rate to 110% from 100% and the lowering of the floor of the lending rate to 80% from 90% have actually reduced the lending rate by more than it announced and increased the deposit rate. We believe the rate cut is generally a positive to the market and marks a small step to interest rate liberalization in China. More in China Cut Interest Rates, The First Time In Over Three Years.

On the data front, Japan Q1 GDP was revised up to 1.2% qoq while GDP deflator was revised down to -1.3% yoy. Australia home loans rose 0.2% in April while trade deficit narrowed sharply to AUD -203m. German trade balance, UK PPI, Canadian housing starts, trade balance, employment and US trade balance will be released later today.