Wall Street senses stimulus

Global markets rallied sharply overnight, as investors pinned their hopes that the US central bank would unleash a fresh round of monetary stimulus, and that a compromise could be reached for bailing out Spain's troubled banks.

According to reports in the European media, eurozone officials are now considering ways of structuring the Spanish bailout that would allow Madrid to save face.

The Spanish government of Mariano Rajoy has been deeply reluctant to accept the humiliation of a bailout, which would force Spain to adopt an austerity and reform package dictated by the "troika” – the European Central Bank, the European Union and the International Monetary Fund.

Accepting a bailout now would also represent a major political embarrassment for Rajoy, who for months has claimed that Madrid was capable of handling the problems of its ailing banks and over-indebted regional governments on its own. But Madrid has now conceded that some form of external assistance will be required now that the country has been shut out of global capital markets.

Madrid, with the backing of Paris, has pushed for the eurozone's bailout fund to lend directly to Spanish banks. But this has been staunchly opposed by Germany. Berlin believes that such a move would reduce the pressure on debt-laden eurozone governments to cut their budget deficits, and it would also leave the bailout fund holding equity stakes in a range of troubled banks.

According to the German daily Die Welt, Brussels is now considering a plan to provide Spain with a line of credit from the eurozone's bailout fund. This would allow Spain to raise money in capital markets itself, which it could use to recapitalise its banks.

And the Financial Times reports that eurozone officials are now considering setting much milder terms for Spain's bailout than were imposed on Greece, Ireland and Portugal. This approach recognises the progress that Madrid has already made in introducing tough austerity measures and structural reforms.

In exchange for receiving a bailout, Madrid would only have to agree to increased external supervision of the country's banks, and to speed up the restructuring of the country's regional savings banks, or cajas.

Meanwhile, the Spanish daily Cinco Dias, says Brussels will demand Spanish banks take further write-offs on their problem real estate loans in exchange for providing bailout funds.

Investor optimism was not muted by the European Central Bank's decision to keep its key lending rate at 1 per cent ahead of the upcoming Greek election. Instead, they were cheered that the ECB was prepared to keep flooding European banks with short-term liquidity.

And their optimism was also fuelled by a report by the Wall Street Journal's Jon Hilsenrath – who has extremely close ties with the US central bank – which suggested that disappointing data on the US economy and growing anxiety over the European debt crisis could prompt a fresh bout of monetary stimulus.

According to the report, the US central bank, which will hold a two-day meeting on June 19 and 20, could consider extending its existing "Operation Twist” program of selling short-dated securities and buying long term bonds in order to push long-term interest rates lower.

Alternatively, the central bank might decide to launch a fresh round of bond buying, or quantitative easing.

Importantly, investors interpreted the report as signalling that Ben Bernanke, the boss of the US central bank, would not be afraid of launching new measures because of the upcoming US presidential election. The report noted that Bernanke only had 18 months left to run on his term as chairman, and had given little indication that he was seeking another. As a result, he "appears especially immune from politics now.”