European Crisis Watch: Recent Events and Upcoming Key Dates

The recent turmoil in Spain has been at the forefront of all investors radars. Whatever the cost of bailing out Spain and recapitalizing its banks may be a priority, the Europeans will be forced to use up the remaining firepower that exists in the bailout funds to do so. Estimates on Wall Street range anywhere from a capital shortfall of 60 billion euros to 150 billion euros. JP Morgan even estimates that a total bailout may cost as much as 350 billion euros, which would wipe out the remaining firepower of the joint bailout funds, the EFSF and the ESM.

Days after it cut Spain's long term rating to BB- from BB+, Egan Jones on 5/29 cut Spain's rating to B. That is five notches in a matter of days. This was a month after S&P cut Spain to just above junk (BBB+) from A, a two notch downgrade. And yesterday, Fitch downgraded Spain to BBB from A-, a two notch downgrade and only two above junk. All in all, credit investors are getting more and more worried that the troubled Spanish banking sector is going to put strain on the fiscal sector and require an Ireland-esque state rescue. This is why debt-to-GDP expectations are rising and contagion fears with them.

After downgrading Spain, I spoke with Bill Hassiepen, co-Head of the Ratings Desk at Egan Jones, and he told me that, "the Spanish Banking system continues to deteriorate and we believe more institutions will require bailouts." Further, he said that, "We believe Spain is not capable of bailing out its banks without help from the ECB. Our conclusion is coming more and more that Spain is becoming more like Greece, European officials are just throwing more and more money at Spain, increasing its debt levels without addressing the fundamental problems, which are excessively high unemployment, and skyrocketing debt levels."

Yesterday, before the downgrade, Spain was able to issue 2-, 4-, and 10-year debt, albeit at higher yields. Yields climbed on all three maturities but the take-up was rather strong, meaning there still is demand. Yields on the 10-year rose about 25 basis points at the auction.ah

Looking forward, rumors are that there will be a conference call tomorrow between European officials and Spanish officials over a bailout of the banking sector. However, Spain has been refuting this, saying they will not ask for a bailout. What is likely is that Spain will wait for the European summit to close on June 29 (it is a two-day event). Spain must be hoping that European leaders will agree on a pan-European deposit insurance scheme, which will allow European funds to bailout Spanish banks, not just Spanish funds. This also follows the Greek election on June 17, which will be of tremendous importance. If the radical Syriza party wins and Greece leaves the euro, the market will have its wrath on Spain.

Next week, we get data on Spanish inflation on Wednesday. The market is expecting a -.2% month-over-month change in inflation. At the end of the month, Spain gets the results of its private audit of the banking sector, which will clarify exactly how large the capital shortfall is currently. This coincides with the Eurogroup meeting, so it is likely that no bailout/recapitalization plan will come to fruition until then.

For those looking for a good way to trade these upcoming events, there are the obvious and then the less obvious plays on Spain. Of the obvious trades, traders could look to short Spanish stocks EWP or for those who trade currencies short the Euro FXE. Also, any move towards insolvency puts a larger burden on Germany, so traders may look to short German stocks EWG. To catch the contagion effects, traders may also consider shorting pan-European stocks as a whole EZU or target specific nations, such as Italy EWI or France EWQ.