US Yields Dived On Safe Haven Flow, USD/JPY Followed

Worries on Spain continue to weigh down on market sentiments. Asian equities are broadly lower today following the -160 pts fall in DOW overnight. Markets are all seeking safe haven and funds flew to US treasuries and drove 10 year yield to 60 years low of 1.62%. Weakness in yields in turn drove yen broadly higher with USD/JPY breaking through recent support of 78.99 to as low as 78.46 so far. Commodity currencies, like Aussie and Loonie, are weak against dollar and yen but the selloff is not as bad as European majors. We'd expect European majors to remain generally weak and the major focus will remain on development in Spain, in particular on how quick the benchmark 10 year yield will march to 7% level, which eventually led to bailout of Greece, Ireland and Portugal.

In response to talk that ECB has rejected Spain's plan recapitalize Bankia, the central bank denied the rejection and simply said it's not being consulted and there is no position expressed. Nonetheless, ECB has stated clearly that the “the funds needed to ensure banks’ compliance with capital requirements cannot be provided by the Eurosystem." That is, anyway, ECB will reject such a plan to inject government bonds into Bankia which in turn be used as collateral for ECB funding, if it happens. So the question now remains on how Spain could fund the EUR 19b recapitalization of Bankia. And more importantly, it's estimated that the total bailout cost of Spain's banking sector is between EUR 50b and EUR 150. And, only EUR 5b is left in the bank bailout fund Spain established in 2009. In any case, external help is needed. To make things worse, continuous rise in borrowing cost will eventually drive Spain to seek rescue.

Spain's capability to meet it's deficit target is another issue. But EU economic affairs commission Rehn said yesterday that they're ready to propose an extension of the excessive deficit procedure deadline by one year to 2014. The would come with the condition for Spain to present a "clear budget plan" and reining in "excessive spending...especially in its autonomous regions". That should ease much pressure for Spain to meet the deficit target of 5.3% of GDP in 2012 and 3% of GDP by end of 2013.

In Greece, market sentiment was again unnerved by 3 new polling results with New Democracy leading in one, Syriza ahead in another and the 2 parties tied in a third. These easily erased the optimism over the weekend that New Democracy was shown leading the election. Moreover, 77% of respondents said the terms of the bailout should be revised. 52.4% believed they should stay in the euro if they were forced to accept the current austerity measures tied to the bailout, while 44.5% said they shouldn't. Still the over 80% said they wanted to remain in the euro.

In addition, speculation of ECB rate cut intensified recently, as reflect with 6-month Euribor rates dropped to two year low of 0.949%. At the moment, Eonia rate forward market is pricing 10% chance of a June but above 20% chance for July cut. However, some analysts argued that the pricing underestimated the chance of June cut as data from Germany is already showing that the largest economy in Eurozone is losing momentum. Recent decline in commodity and energy prices also leave additional room for easing. After all, market could start to pricing in high chance of rate cut should situation in Spain and Greece deteriorate further.

On the data front, Australia building approvals dropped sharply by -8.7% mom. UK Gfk consumer confidence improved to -29. Japan industrial production rose 0.32%.German unemployment, Eurozone CPI will be closely watched today. meanwhile, US will also release ADP employment, GDP revision and jobless claims.