The pain in Spain – redux

April 17, 2012

Spain’s borrowing costs are likely to soar at an auction of 12- and 18-month T-bills after its 10-year yields were pushed through the totemic 6 percent level on Monday. The history of the euro zone debt crisis shows that once above 6 percent the spiral accelerates and before you know it you’re at 7 percent – the level generally seen as unsustainable for state financing.

Worryingly, Spain is dragging Italy’s yields up in its wake. But in Spain’s case, there are strong reasons for caution about imminent disaster. The government cannily used ECB-created benign market conditions in the first part of the year to shift nearly half its annual debt issuance needs already and the banks – which look like they will need recapitalization at some point – are well funded for now having also loaded up on the European Central Bank’s three-year liquidity splurge.

We also know Europe’s banks, too scared to invest elsewhere, are depositing 700-800 billion euros back at the ECB daily. If Madrid could engender a shift in confidence, some of that money could flow back into its bonds, particularly by Spanish banks.

There is no getting away from the fact that confidence has evaporated since Prime Minister Mariano Rajoy ripped up Spain’s agreed deficit target for 2012 without consulting his partners. One way of clawing it back could be a framework that would guarantee the autonomous regions would agree to tough debt-cutting measures.

Last year’s ballooning of the deficit beyond forecast was in large part down to the regions’ spending. Government sources told us yesterday that Madrid may intervene to curb regional finances, which account for around half of national public spending, in return for some help in raising finance from the markets which some are finding difficult. Ministers meet the regional government heads on Wednesday. They have to present plans to save around 15 billion euros in early May.

Today, Madrid aims to raise up to 3 billion euros and will then try to sell up to 2.5 billion of longer-term bonds on Thursday. 12-month yields stood at around 2.7 percent on the secondary market yesterday whereas the last 12-month auction was done at a yield of 1.4 percent, so a big jump is inevitable.

The only other possible sentiment shifter in the short-term would be if the IMF managed to raise significant new crisis-fighting resources which could be deployed to defend a country like Spain (even though Christine Lagarde insists the monies would be used to help non-euro zone nations inadvertently caught up in the backwash). Overnight, she was quoted by Italy’s Il Sole 24 Ore as saying she was after more than $400 billion. EU sources have told us similar — $400-500 billion. That’s less than was first talked about and there are doubts it is deliverable.

The euro zone deal last month on its new rescue fund was spun as more than it was. Finance ministers claimed an 800 billion euros firewall had been erected. In reality, it was really only 500 billion. It’s not that the latter is an insignificant sum, it was the cack-handed attempt to overplay it that is likely to have gone down badly with non-European contributors to the IMF.

Furthermore, the anointing of the U.S. pick to head the World Bank despite pressure for an emerging nation candidate may not do much for harmony at the IMF/G20 meeting in Washington at the back end of the week. However, given the possible ramifications of doing nothing on the debt crisis front remain too ghastly to contemplate, a deal is likely to be done soon. Japan has committed $60 billion today.

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