Sentiments Improve But Face Test Of Spain Auction And Bernanke Testimony

A couple of developments gave markets a overnight which led to strong rally in Dow for as much as 286 pts, or 2.37%. Firstly, there were talks that Germany and EU officials are looking at resolutions to Spain's banking crisis even though assistance is not yet sought by Spain. Intensive contingency planning is believed to be carried out in Berlin and Brussels that could involve giving Spain access to EFSF or ESM without having to impose tough reforms like Greece, Portugal and Ireland. Secondly, ECB President's message as the press conference was seen as leaving doors open to further easing even though ECB just stand pat for the moment. Thirdly, Fed's Vice Chairman Yellen urged to provide further policy accommodations either through "forward guidance" or "additional balance-sheet actions." Positive sentiments then carried on in Asian session as China will delay the new tougher bank capital rules to 2013. Positive employment data from Australia also helped.

Nonetheless, there are two important event risks ahead today. Firstly, Spain's auction of 2-, 4- and 10-year bond today will be a crucial test. Spanish Treasury Minister Cristobal Montoro said earlier this week that "the risk premium says Spain doesn't have the market door open" and Spain has problems in "accessing markets" for refinancing its debt. Demand in today's auction and the average yields will be closely watched to see if Spain could still have reasonable access to market funds. Benchmark 10 year yield shot to 2012 high at around 6.7% last week and is back below 6.3% again. But it's vulnerable to another spike should today's auction disappoint. France will also sell debt ranging from 2019 to 2060 today, with first sale of 50 year bonds since 2010.

Secondly Fed chairman Bernanke will testify before Congress today. There are speculations that Bernanke will starting hinting on additional easing today or at the post policy meeting press conference on June 20. But that is far from being certain. Opinions from Fed officials are varied. Vice Chairman Yellen said yesterday that there are a "number of significant downside risks to the economic outlook" and 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." She also warned that "highly destabilizing outcomes cannot be ruled out" as European financial conditions deteriorate.

Atlanta Fed Lockhart said that "further monetary actions to support the recovery will certainly need to be considered" San Francisco Fed Williams urged Fed to "stand ready to do even more if needed to best achieve our statutory goals of maximum employment and price stability." And, Williams noted that "an effective tool would be further purchases of longer-maturity securities, potentially including agency mortgage- backed securities." However, a day ago, St. Louis Fed Bullard said that 2012 outlook has "not changed significantly" so far and noted that change in US monetary policy won't alter situation in Europe. Meanwhile, Dallas Fed Fisher simply said that "short of an implosion, I cannot support further quantitative easing."

The latest Fed Beige Book described that the overall economic activity expanded at a "moderate," "modest" or "steady" pace in 11 of the 12 Districts (the pace of expansion in Philadelphia slowed slightly during the period). The report also stated that "lenders in most. Districts noted an improvement in loan demand and credit conditions." The economic outlook remained positive but those surveyed "were slightly more guarded in their optimism." Yet, the language used in the report does not seem that the market conditions would lead to QE3.

The China Banking Regulatory Commission said yesterday that it will delay the implementation of the tighter capital rules until January 2013. There have been fears among banks that the new rules would curb lending during a time China is trying to boost growth. And the CBRC said that the delay will now give a reasonable transition period to meet the requirements while maintaining "appropriate credit growth". Meanwhile, CBRC also said that China will "cut the risk-weighting levels for loans to small firms and individuals to increase credit supply to those areas and provide more support for the real economy."

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. Concerning the macroeconomic developments, the ECB acknowledged that there is "a weakening of growth and heightened uncertainty" in 2Q12. Policymaker retained that the bloc's economy would "recover gradually" but the ongoing sovereign debt crisis would have negative impact on credit conditions and dampen the "underlying growth momentum."

The staff projections for the eurozone showed that annual real GDP growth would be in a range between -0.5% and 0.3% for 2012 and between 0.0% and 2.0% for 2013. Concerning inflation, the staff forecast that annual HICP inflation would be in a range between 2.3% and 2.5% for 2012 and between 1.0% and 2.2% for 2013. More in ECB Left Interest Rates Unchanged, Draghi Questioned the Effectiveness of Monetary Policies on Crisis.

BoE will announce rate decision today but is expected to stand pat of rates and asset purchase target, and thus, could be a non-event. On the data front, Australian data showed stronger than expected growth in employment by 38.9k while unemployment rate edged higher to 5.1%. Japan leading indicator dropped to 95.1 in April. Swiss unemployment, CPI, FX reserve, UK PMI services, US jobless claims and Canada Ivey PMI will be released later today.