MacroScope

Spanish rescue could cause collateral damage for Italy

September 21, 2012

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Mounting speculation that Spain is prepping for a bailout begs the question – what happens to Italy?

Sources told Reuters Spain is considering freezing pensions and speeding up a planned rise in the retirement age as it races to cut spending and meet conditions of an expected international sovereign aid package.

Markets took this to mean it was preparing the ground for eventually asking for help. According to Lyn Graham-Taylor, fixed income strategist at Rabobank:

Spain is trying to front-run the reforms that would likely to be required as part of the (bond-buying) programme so that politically it’s more acceptable.

If Spain seeks aid, it could trigger European Central Bank bond-buying and many say this would improve the conditions in peripheral markets as a whole, including Italy.

David Keeble, global head of fixed income strategy at Credit Agricole, has a different – and more sombre – view of what a Spanish bailout would mean for its neighbour across the Mediterranean:

I don’t think the ECB coming in would drive down the level of Spanish yields significantly … and it could of course set in motion pressure on Italy and that’s not helpful at all.

If you know that Spain is going to be potentially bought, everybody will be buying Spain and getting out of their Italian exposure, so you are really just passing the ball around the street.

He said people would be putting on trades to sell Italy to buy Spain in the front end of the curve, which is where the ECB has said potential intervention would be focused.

That’s the thing that scares me that you are going to drag in other people by accepting this bailout. The market goes after the next weakest and that clearly will be Italy – which is a bigger market and the ability to help Italy is a lot lower than the ability to help Spain.

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