Spain goes to market

July 19, 2012

Spain will auction up to three billion euros of a mixture of debt having enjoyed sharply lower borrowing costs at a T-bill auction earlier in the week. However, with 10-year yields still perilously close to 7 percent, it’s pretty clear that the latest austerity drive by Prime Minister Mariano Rajoy – which will take 65 billion euros out of the economy by the end of 2014 – seems to have achieved little more than settling the bond market slightly.

All the efforts of the past few weeks – the bank bailout, the fresh austerity measures and the leeway on deficit targets from the euro zone – appear aimed at keeping a full Spanish sovereign bailout at bay. But it’s quite possible that all these efforts are actually hastening a full bailout rather than warding it off by driving Spain deeper into recession and cutting state revenues.  That is something the euro zone rescue funds with a maximum of 500 billion euros at their disposal, 100 billion of which is earmarked for Spain’s banks, cannot really afford.
We’ll get the final, firm details of the Spanish bank rescue on Friday.

Secondary markets prices suggest the yields on the two-, five- and seven-year bonds will all rise from the last time these maturities were sold and Spain’s advantage of having front-loaded debt issuance in the first half of the year has evaporated as looser deficit targets agreed with Brussels and Madrid’s commitment to help its debt-laden regions have added more than 20 billion euros to the amount it thought it would have to raise in 2012.

France will auction debt worth a whopping 10 billion euros or more. The difference with Spain could not be more stark. Whether France, given its debt levels and unreformed working practices, should be viewed as “core” is a matter for debate. But it is, at least for now. While Spain has to pay 7 percent to borrow over 10 years, Paris can do so at little over two percent. Germany sold two-year debt at negative yields for the first time yesterday.

Ultra-low borrowing costs could be hoped to boost consumption but are a disaster for savers and institutions such as pension funds, so people may have to save even more and spend less to try and avoid an old age in poverty. Ergo, the net effect could be a further drag on economic recovery. The paradox is that further central bank stimulus to ward off a global slump will drive the borrowing costs of “safe havens” yet lower, compounding the problem. So could more QE do more harm than good? That’s a question to ponder since it’s pretty much the only policy lever left to pull.

Elsewhere, the Bundestag will vote on the Spanish bank bailout in special session with Finland’s parliament set to do the same. Both should pass it without problems but Angela Merkel could get a bloody nose if internal dissent within her coalition forces her to rely on opposition votes. The objection of potential rebels is that there is not yet any clarity over whether liability for the bailout, of which Germany would guarantee nearly 30 percent, rests with the state or banks. For the Finns, if the Spanish loan is to be funded through the euro zone’s existing EFSF bailout fund (likely since the German constitutional court is holding up the inception of the permanent ESM fund by delaying a ruling on complaints about it until September), the agreement is conditional on Spain providing guarantees to Finland for its share of the bailout.  A deal to sort that out has already been struck with Madrid.

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