The Optimism Over Spain Ebbs

Investors appear to be increasingly skeptical that a bailout agreement with Spain will solve the country’s financial problems. The brief momentum of optimism, seen last week, fizzled on Monday as traders realized that the problems are slightly higher than anticipated. Over the weekend, the Spanish government requested funds from the European Union totaling $100 billion euro ($129 billion). The request was slightly larger than many economists were expecting. Unfortunately, some analysts have pointed out concerns that these funds will only provide short-term relief and not resolve the financial problems plaguing Europe’s fourth largest economy.

The doubt in the marketplace caused traders to shed Spanish debt. According to an article from Bloomberg, 10-year yields for Spanish Treasurys rose dramatically during Monday’s session. They were up 29 basis points to high of 6.51%. Another concern plaguing the bailout process is that many still do not know exactly where the money will come from. Investors have been left wondering as to whether the old European Financial Stabilization Mechanism (EFSF) or the new European Stability Mechanism (ESM) facility will be tapped to provide the funding necessary to shore up Spain’s banking system.

According to some market analysts, by using the ESM facility could create long-term doubt on Spain’s sovereign debt and impact the country’s ability to attract investors to buy debt. “For bondholders the difference is crucial, EFSF loans are [on equal footing] with the claims of the other bondholders, while ESM claims have priority on the existing bondholders (who are subordinated). Getting all of a sudden €100B of claims ahead of you in case of default isn’t exactly an incentive to keep your bonds or to buy more bonds,” wrote analysts from KBC in a daily research note. The uncertainty has had a major impact on the euro.

During Monday’s session, EUR/USD managed to break above initial resistance at 1.2600 and hit a high of 1.2668; however the cross quickly dropped in the North American session and closed at a low of 1.2482. There is some initial support at 1.2400 but with so much fear plaguing the European economy the market could test recent the June 1 low at 1.2306. The euro also took a big hit against the sterling during Monday’s session. Brief optimism caused GBP/EUR to break below support at 1.2300 but by the end of the day, the pound has managed to recover those gains and more closing at 1.2404, just a few pips off of its session high. Although the focus right now is on Spain, it could easily shift to Italy, which investors believe is next on the chopping block or back to Greece, which will be holding their new elections on June 17.

By David Frank, Chief Market Analyst, AvaFX Forex Trading

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