Asia Session: Hopes of more policy easing from Beijing take the spotlight off Spain

By Chris Tedder, Research Analyst FOREX.com

It was a choppy session for investors in Asia, with high beta assets initially being dragged down by concerns about the Spanish banking sector and then rising on the back of speculation China will ease policy further. EUR and AUD were two of the hardest hit by the initial risk sell-off as both currencies plunged against the dollar. EURUSD looked ready to push back below 1.2500, whilst AUDUSD just managed to hold above 0.9800.

The yield on Spain's 10 year government bond spiked above 6.5%, perilously close to the 7% level that prompted bailouts of other European nations. Spain's PM Rajoy was on the wires attempting to reassure the market that his country's banks would not require international assistance, but the market was clearly not convinced. Also, the PM added that if banks started to collapse it may cause the entire country to collapse. The whole situation is not being helped by the fact that Spain suggested tackling the rising cost of borrowing by swapping EUR19 bn in government bonds directly for equity in BFA, which is basically admitting there are funding problems. Accordingly, investors are very concerned about the Spanish banking sector.

Later in the session, hopes of more policy loosening from China lifted sentiment throughout Asia. The Chinese government has become very vocal of late, at least by China's standards, about its desire to deliver more policy easing if needed. Thus, with the situation in Europe deteriorating the market is expecting the Chinese government to move to stimulate growth. Overall, China is the largest source of demand and, in turn, the biggest driver of growth in the world, accordingly any speculation surrounding more growth supportive policy from Beijing is a positive for risk assets.

In Japan, disappointing economic data added fuel to the early risk sell-off. Economists were predicting Japan's jobless rate to remain unchanged at 4.5%, but a persistently high yen and a deteriorating situation in Europe is proving more detrimental than first thought, resulting in an increase in the jobless rate to 4.6%. Furthermore, retail sales increased less than expected - 5.8% year-on-year increase to April, compared with estimates of a 6.0% increase. Large retailers' sales decreased more than expected, coming in at -0.5% for April (exp. -0.3%, prior 5.1% revised).

At the time of writing the ASX200 and Nikkei225 are in the green by around 0.94% and 0.24% respectively. Also, G10 currencies have managed to claw back some ground from the dollar. AUDUSD is currently testing a resistance level around 0.9860 and a break through this level may see the pair push back above 0.9900, but the uncertainty in Europe may keep the pair below parity for the time being, at least until the RBA meeting a week from today. Current interbank pricing suggests investors have priced in a 126% chance of a 25 bps cut and a 63% chance of a 50 bps cut (42% chance for a 75 bps cut). Whilst Australia's inflation outlook provides scope for a 50 bps cut, we think there more opportunity of a surprise on the upside for the Aussie (i.e. a 25bps cut causing AUD to spike higher).

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