Spanish yield curve flattens, along with Europe’s fortunes

July 20, 2012

Ten-year Spanish government bond yields hit their highest levels since the euro was created – above 7 percent – on growing doubts that the euro zone’s fourth largest economy will be able to avoid a full-blown sovereign bailout.

News that Spain’s heavily indebted eastern region of Valencia would ask Madrid for financial help reinforced concerns the country may eventually run out of funds. The rubber-stamping of a rescue package for Spain’s troubled banking sector did little to allay concerns.

Short-dated bonds came under particular pressure, flattening the Spanish yield curve further in a sign of mounting credit worries. Five-year bond yields hit a euro-era high of 6.928 percent, flirting with the widely dreaded 7 percent mark.

Charles Diebel, head of market strategy at Lloyds Bank says:

The more pressure you put on the front end … it is saying that the near-term risk of default is going up through the roof. It’s exactly the dynamic you saw in all of the other curves before they went into a bailout. You actually saw things like the Greek curve invert.

Asked when such an inversion — where short-term yields would actually surpass long-term ones — may take place for Spain, he said:

It always happens faster than you think. They haven’t got the summer, put it that way.

The other issue, of course, are the implications for Italy. Adds Diebel:

If they can push Spain into a bailout then they are going to go straight for Italy.

Not very reassuring then, that in late European trading on Friday, ten-year Italian bonds yielded 6.20 percent – only a whisker away from the 6.23 percent offered by equivalent bonds issued by Ireland, one of the countries to have already received a sovereign bailout.

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