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Spanish government bonds have had a good run since the European Central Bank said it would protect the euro last year. But some analysts say the threat of a rating downgrade to junk remains an important risk.
Credit default swap prices are discounting such a move, according to Markit. Spain is only one notch above junk according to Moody's and Standard & Poor's ratings, and two notches above junk for Fitch. All three have it on negative outlook. Bank of America-Merrill Lynch says it sees a “high probability” of a sovereign rating downgrade in the second half of the year.
As the table above shows, a cut to sub-investment grade would prompt Spanish sovereign debt to fall out of certain indices tracked by bond funds, resulting in forced selling, which could drive Spanish borrowing costs higher.
Ten-year Greek government bond yields tumbled to their lowest in nearly three years one day after Fitch upgraded the country's sovereign credit ratings.
Borrowing costs fell to 8.21 percent - the lowest since June 2010, just after Greece received a bailout from the International Monetary Fund and European Union. The difference between 10- and 30-year yields was also at its least negative since that time.
Are European bond investors looking for love in all the wrong places?
The premium bankers demand to hold various types of euro zone debt over that of Germany has recently come down. In normal circumstances, this might suggest markets are no longer discriminating between the risks associated with different member countries’ bonds. But analysts say the recent convergence is based on a precarious belief of ECB action rather than any real improvement in economic fundamentals.
Spain and Italy still offer a comfortable premium over Germany. But a narrowing in yield spreads that is being driven by a fall in the funding costs of Spain and Italy, rather than by a rise in German yields, gives reason for pause.
"Reality is sticky." That was the core of Adam Posen's message to German policymakers on their home turf, at a recent conference in Berlin.
What did the former UK Monetary Policy Committee member mean? Quite simply, that the types of structural economic changes that Germany has been pushing on the euro zone are not only destructive but also bound to fail, at least if history is any guide.
It wasn't just the Nikkei. Euro zone government bonds rallied following Japan's announcement of a massive new monetary stimulus. That sent yields on the debt of several euro zone countries to record lows on bets that Japanese investors might be switching out of Japanese government bonds into euro zone paper, or might soon do so.
The Bank of Japan on Thursday announced extraordinary stimulus steps to revive the world's third-largest economy, vowing to inject about $1.4 trillion into the financial system in less than two years in a dose of shock therapy to end two decades of deflation.
Money markets largely braved Cyprus’s bailout saga last week, but figures showing liquidity conditions are tightening suggest sentiment may not be as resilient the next time around.
Data from CrossBorder Capital, an independent financial firm that specialises in analysing global liquidity flows, shows the euro zone saw its biggest capital outflow in March since late 2011 – around the time the ECB injected liquidity into the financial system.
The problem of a “democratic deficit” that might arise from the process of European integration has always been high on policymakers’ minds. The term even has its own Wikipedia entry.
As Cypriots waited patiently in line for banks to reopen after being shuttered for two weeks, the issue was brought to light with particular clarity, since the country’s bailout is widely seen as being imposed on it by richer, more powerful states, particularly Germany.
The Cypriot saga has thrown the spotlight on Slovenia, which is also a small euro zone country struggling with an over-burdened banking sector.
Slovenia's mostly state-owned banks are nursing some 7 billion euros of bad loans, equal to about 20 percent of GDP, underpinning persistent speculation that the country might have to follow other vulnerable euro zone countries in seeking a bailout.
Breaking with previous EU practice that depositors' savings are sacrosanct, Cyprus and international lenders agreed at the weekend that savers would take a hit in return for the offer of 10 billion euros in aid.
Cypriot ministers are now scrambling to revise a plan to seize money from bank deposits before a parliamentary vote on Tuesday that will either secure the island's financial rescue or threaten its default.
The euro zone slipped deeper into recession than economists expected in the fourth quarter of 2012 as Germany and France– the region’s two largest economies - shrank 0.6 percent and 0.3 percent respectively on a quarterly basis.
The data is a reminder of the plight still facing the euro zone as it struggles to shake off a three-year debt crisis, which the region has sought to fight with harsh, growth-crimping austerity.