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March 25th, 2012 at 10:42 am

Spain in the Hot Seat.

With Greek situation normalized (for now), markets are shifting attention to Spain. For a while, it looked like this country was trying to target a 5.8% deficit in 2012, rather than the 4.4% it had promised the EU. Under pressure from Union officials, Madrid eventually agreed to 5.3% for the year. Still, this is way above the EU-mandated deficit target of 3%, a level Spain is expected to reach next year. It will be extremely difficult to achieve, considering the deficit for 2011 was 8.5%, which means that Spain must make the deepest cuts of any Eurozone country outside Greece. With the highest EU unemployment of about 23%, the economy can easily fall into its second recession in three years.

Markets clearly do not have much faith in Spain, fearing higher than promised deficit or even possible bailout. In the past two weeks, Spain has had a higher yield than Italy, which just a month ago was the economy most at risk following the bailouts of Greece, Ireland and Portugal. On Friday, the Italian 10-year yield was 0.4 percentage points below Spain’s at 5.14%. This happened in spite the fact that European banks have plenty of capital from the LTRO and were expected to use it for sovereign bond purchases. After all, at 5% these are attractive yields in the low-rate environment across the globe. We should watch the 5.5% yield level, as a move above could spell real trouble for Spain and the Euro, perhaps as early as this week.

Last week I discussed trades in the GBP-JPY, and now it could be a good time for more short trades in Yen crosses. The NZD-JPY, for example, might be a decent sell under 66.50 using the hourly chart. Since the price closed well above 67.00 on Friday, it could take some time before this trade happens. As for shorter-term activities, I will look for gaps at the opening, and try to play them, if they develop. Have a great trading week!

Mike K.

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