For insatiable markets, Spanish steps fall short

April 6, 2012

So much for the lasting power of the ECB’s 1 trillion euros in cheap bank loans. Spain is again looking like a basket-case, more because of market dynamics rather than any particular policy misteps.

Many observers have praised Spain for its willingness to implement reforms. And yet the markets have another idea. The cost of insuring debt issued by Spanish banks against default has risen sharply over the past month, as a tough budget this week did little to soothe concerns over the country’s deteriorating fiscal situation.

Default insurance for Santander is up 52 percent since March 1 to 393 basis points and the equivalent for BBVA jumped 54 percent over the same period. Both Spanish banks underperformed the Markit iTraxx senior financials index – which measures Europe’s financial institutions’ insurance, or credit default swap prices. It rose by 20 percent over the same period.

Markit analyst Gavan Nolan said a lot of the move was caused by the European Central Bank’s low-interest, three-year loan programmes, or LTROs, that have pumped money into the banking system.

They’ve actually tightened the relationship between the banks and the sovereign. So the banks have been buying sovereign debt and that has made their fortunes even more intertwined than they have previously.

Pressure on Spanish government debt has had a knock-on effect on banks. Yields on 10-year Spanish bonds this week rose to their highest since December 2011 at 5.8 percent after the Spanish Treasury had to pay more dearly to borrow in an auction.

The cost of insuring Spanish sovereign debt against default meanwhile has jumped 111 basis points to 467 bps over the past month, according to Markit data. This means it costs $467,000 annually to buy $10 million of protection against a Spanish default using a five-year CDS contract.

Spain’ tough budget this week has not been enough to calm investor nerves. Many fear too much austerity could choke an already struggling economy where unemployment rose to a staggering 22.9 percent in the fourth quarter of 2011 — the highest in the European Union.

It’s a vicious cycle all too reminiscent of an even more troubled European state: Greece.

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