Spanish bonds on the block

By Mike Peacock
September 20, 2012

Having done so with a t-bill sale on Tuesday, Spain will continue to try and cash in on the relatively benign market conditions created by the European Central Bank by selling up to 4.5 billion euros of 3- and 10-year bonds. It hasn’t tried to sell that much in one go since early March, when the ECB’s previous gambit – the three-year liquidity flood – had also imposed some calm upon the markets, albeit temporarily (there’s a lesson to be learned there).

Yields are likely to fall sharply from the most recent equivalent auctions but even so, it looks unlikely that Madrid can meet some daunting looking refinancing bills before the year is out, without outside help. Prime Minister Mariano Rajoy’s hesitation about making a request for bond-buying help from the ESM rescue fund, with the ECB rowing in behind, has already pushed Spanish 10-year yields back up towards six percent after a more than two-point plunge since ECB chief Mario Draghi issued his “I’ll save the euro” proclamation in late July.  They had peaked around 7.5 percent before that.

With the ECB having pledged to buy bonds if necessary, but only at the shorter end of the maturity scale, the three-year bonds should be snapped up. The 10-year issue may be a harder sell. The danger is that Spain (and Germany, which is saying Madrid shouldn’t take a bailout unless market pressure returns with a vengeance) dithers for so long that the positive sentiment created by Draghi dissipates completely.

Aside from the auction, there is an important looking meeting between Rajoy and the president of the powerful Catalonia region, which has sought government help with its debt. A combination of spiraling regional debts, deepening recession and stricken banks means Madrid is highly unlikely to dig itself out of this hole alone. There will be a political temptation to wait until regional elections in late October are out of the way but that looks a stretch. More likely is the wheels start moving after the government unveils its 2013 budget and a new round of structural reforms at the end of September, when detailed stress tests of the country’s banks will also be published.

We know that China is watching events closely although it has never followed through on pledges to buy more euro zone bonds. Today, Chinese Premier Wen Jiabao will meet European Commission President Jose Manuel Barroso and Herman Van Rompuy, president of the European Council in Brussels. Trade issues and disputes will be to the fore but the euro zone crisis is bound to figure too.

The Greek saga rumbles on. Coalition leaders meet to try and agree the composition of nearly 12 billion euros of cuts required to keep bailout money flowing after the troika of EU/IMF/ECB inspectors rejected their Plan A.  The odds are that whatever the evidence of the numbers, a way will be found to give Greece more time and money to put it notionally back on track to meet its targets, rather than allow it to slide into default now and threaten to engulf Italy and Spain in the wash.

Following the Draghi rally, some analysts are saying what is needed to sustain the upward move is evidence of improvement in the real economy. Flash euro zone PMI  surveys for the euro zone, Germany and France are unlikely to provide much evidence of that.

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