Merrill Lynch Wealth Management’s Bill O’Neill sees Spanish bailout as ‘inevitable

Bill O’Neill, chief investment officer for Europe, Middle East and Africa at Merrill Lynch Wealth Management believes that Spain’s bailout is a formality following the latest moves by the ECB on eurozone sovereign debt.

Last week, ECB President Mario Draghi announced details of the new policy mechanism designed to purchase peripheral sovereign debt from the secondary market. This is an important step in enhancing the eurozone’s crisis management tools as the ECB adds weight to Mr. Draghi’s previous comments that the eurozone project is “irreversible”. Next steps will depend on whether Spain will be willing to request a formal bailout. We see this as inevitable, thereby allowing the ECB to purchase Spanish sovereign debt.

We think that markets will still wait to see the next steps Spain takes in regards to requesting support officially. Once there is clarity on Spain’s decision to enter a program formally, this could mark the next leg higher for global equity markets, especially if it coincides with greater clarity on the U.S. election outcome and year-end “fiscal cliff”. Irish yields could move lower given the ECB may begin purchasing this sovereign’s debt, yet the market has already discounted a lot. Spanish and Italian spreads will likely only move lower once there is confidence that the respective country is signing up to a program.

In all the policy developments, it is easy to forget that the underlying economic progress in the eurozone remains lacklustre, with a recession in the region a foregone conclusion over the coming quarters in our view.

Across the Atlantic, disappointing US labour data last Friday increased the probability that the Federal Reserve will undertake a third instalment of quantitative easing when the Federal Reserve Open Market Committee meet this week. We had recently commented that for the Fed to undertake QE3 as soon as this week would require a very disappointing payrolls release, exactly what was delivered. While it is not guaranteed that the Fed will expand its asset purchases again this week, it is increasingly becoming the case. In such an event, we think the Fed may focus its purchases on housing-related assets to support a sector that has recently shown some signs of life.


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