Following are five big themes likely to dominate thinking of investors and traders in the coming week.
1/ WAITING FOR THE GREAT LEAP FORWARD
Financial markets have plenty to preoccupy them before a Greek election on June 17 that could well decide whether the country stays in the euro zone. The sharp fall in Spanish financial asset prices, which has the potential to force European policymakers' hands, is the latest episode in a long-running saga that is sucking in one highly-indebted euro zone country after another. With fiscal union and common euro bonds proving elusive and long-term goals, the European Commission is touting a euro zone “banking union”. Deeper financial integration may appear more feasible than ceding national fiscal sovereignty. But details of what such a union means, how it would work, who would pay for any euro zone-wide deposit guarantee scheme, and how national resistance to some elements of the proposal would be overcome are just some of issues that need to be clarified before financial markets view the ideas as the long-awaited great leap forward.
2/ HAS THE ECB GOT A NEW SPELL?
Money market pricing suggests there is no more than a very slim chance that the European Central Bank will cut its refinancing rate by a quarter percentage point to 0.75 percent on Wednesday. Still, mounting pressure on Spanish bonds is stoking speculation in the wider financial markets that the ECB will signal a willingness to conjure up more emergency measures. Talk of more long-term cheap loans (possibly with five-year terms), modifications to collateral rules, and a resumption of bond buying are just a few of the options that have been mooted by analysts. But the magic of huge injections of liquidity has not eased pressure in the secondary market, and bond buying has only slowed rather than permanently reversed the previous rise in yields. Moreover, the position the Bundesbank staked out in its last monthly report could result in the tone of the ECB news conference being less accommodative than expected by some traders. Any disappointment would risk filtering through to stress gauges, such as Euribor/Eonia spreads, and take a toll on peripheral euro zone bond and stock markets.
3/ ACCIDENT WAITING TO HAPPEN
Yield curves are flattening anew in the euro zone periphery, with Ireland's curve even inverting again in the past week, as the rise in shorter-dated yields outpaces the yield increases further along the curve. This trend is particularly worrying for Spain, which has been tending to issue shorter-term debt. Madrid has so far rejected any suggestion that it will need a bailout but its 10-year borrowing costs are fast approaching 7 percent - a level that Greek, Portuguese and Irish yields breached shortly before these countries had to ask the EU/IMF for help. Domestic banks and investors have so far taken up some of the slack as international investors have cut their holdings of Spanish debt. But ECB data that shows Spanish banks are losing their appetite for domestic government debt will be worrying if it becomes a trend, with Thursday's bond auction the most immediate test.
4/ STOCKS PAINT YOU A PICTURE
Spain's stock market has just suffered its biggest monthly decline since late 2010, with the financial sector hard hit. Other stock markets are catching the Spanish flu and there is a reassessment of just how defensive traditional defensive stocks are in the region. Utilities and some telecom firms are viewed as too dependent on recession-hit consumers in their home country. They are also vulnerable to being slapped with unexpected taxes by cash-strapped governments. But underperformance is not correlated with euro zone membership, as the DAX shows. German equities are still just about up in the year to date (unlike the MSCI global index or the FTSE). It is unclear how long that outperformance will last if emerging economies grow more slowly than expected, as India did in the first quarter, given Germany's reliance on exports.
5/ THE PRICE THE EURO PAYS
The euro's slide against the dollar has accelerated. Moreover, broad-based dollar gains are creating a dynamic that is compounding traders' pessimism about the single currency's outlook - fewer emerging market central banks are going to be recycling dollars into euros given that some of them are now intervening to slow their currency's appreciation against the dollar. And yet, the Swiss National Bank ceiling for the Swiss franc's exchange rate against the euro is holding firm at 1.20. The central bank has been adamant that it will defend the ceiling at all costs and even revealed that it is drawing up plans for emergency measures such as capital controls if the euro were to break up. By contrast, Japanese efforts at managing the yen's exchange rate have so far been limited to rhetoric and implied volatility may need to rise further before traders view intervention as a more serious threat. - Reuters