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Thursday, 17 November 2011

Interest on Spanish bonds is soaring; spreads on bonds of 'stable' countries vs ‘ bunds’ are increasing too.

It could be expected that, after the relative relief of the installation of Mario Monti’s new  technocrat government in Italy, the arrows of the financial markets would be aimed at another victim.

And it was not hard to predict what victim this would be: Spain. The country with its disastrous economic situation, its disastrous (youth) unemployment, its disastrous real estate problems, its ailing manufacturing and services industries and its total lack of economic perspective would be a sitting duck for the markets. And indeed this happened.

Bloomberg reported today, of which I show the pertinent snips:

French, Italian Bonds Rise on Euro Crisis Optimism; Spanish Notes Decline

Italian government bonds climbed after the European Central Bank was said to buy the securities and German Chancellor Angela Merkel called for political action to stem the debt crisis.

Ten-year Italian yields fell a second day as new leader Mario Monti pledged urgent action to curb the nation’s deficit. French bonds rallied after the nation sold close to the maximum amount on offer at an auction of notes. Spanish bonds sank, driving 10-year yields to the highest since before the euro was introduced in 1999, as borrowing costs climbed to the most in at least seven years at an auction of securities.

The yield on 10-year Italian bonds fell 17 basis points, or 0.17 percentage point, to 6.84 percent at 4:55 p.m. London time. The 4.75 percent securities maturing in September 2021 rose 1.03, or 10.3 euros per 1,000-euro ($1,352) face amount, to 86.0.

Italian five-year notes rallied, pushing yields 23 basis points lower to 6.70 percent after the ECB was said by four people with knowledge of the transactions to have bought the nation’s debt today. A spokesman for the central bank in Frankfurt declined to comment when contacted by phone.

“It seems the ECB has been in the markets and that’s turned around the fortunes for Italy today,” said Nick Stamenkovic, a fixed-income strategist at RIA Capital Markets Ltd. in Edinburgh. “It just shows in these illiquid conditions how quickly the market can move.
The question going forward is how much is the ECB is going to intervene, because clearly it’s the only buyer in town.”

French-German Spread
The difference in yield, or spread, between French and German 10-year bonds narrowed 16 basis points to 174 basis points, reversing an earlier move that pushed the gap to as much as 204 basis points.

The 10-year Spanish yield climbed seven basis points to 6.48 percent, after reaching a euro-era record 6.78 percent. At today’s sale, Spain agreed to a yield of 6.975 percent, up from 5.433 percent when it sold 10-year bonds on Oct. 20. That’s the highest rate since at least September 2004.

“There’s no doubt it was a bad auction,” said Padhraic Garvey, head of developed-market debt strategy at ING Groep NV in Amsterdam, referring to the sale of the Spanish January 2022 securities. “This week has been the worst week of the crisis so far, given where yields are.”

The comment on the ECB ‘being the only buyer in town’ shows how deep the crisis is hitting the financial markets now. The Italian bond yields dropped solely by artificial demand from the ECB, but this could be reversed again in a matter of minutes.

One thing is for sure and that is that Spain can use some ECB intervention too in the coming weeks. The country is now in the crosshairs of the financial markets and these will have no mercy. It is not so much the point if Spain can pay back its debt with an interest of > 7%. Spain can pay back its debt, until it can’t.

The real point is that the financial markets don’t trust Spain one bit anymore and can easily increase the interest rates until 8% or higher, when investors deem this necessary. Spain is currently in a situation where the belief in a happy ending is deteriorating very quickly and where the strains of the Spanish government to stem the tides on the financial markets are totally useless. That the country has a relative low debt vs GDP also doesn’t matter anymore.

And Spain will not be the last country being in the crosshairs of the markets, when contagion spreads further: Belgium, France, the East-European countries and eventually the stable countries Austria, Finland, The Netherlands and … Germany.

That ‘stable’ countries like Austria, Finland and The Netherlands are not as invincible as the governments want you to believe, is shown by the following article in the German online newspaper Deutsche Welle:

Higher bond rates stoke fears of a spread of the eurozone debt crisis

Interest rates have jumped sharply for France, Belgium, Austria, Finland and the Netherlands. This has fueled fears that the eurozone's sovereign debt crisis could be about to spread even further. 

The president of the European Commission, Jose Manuel Barroso said that the 17 countries that use the euro were facing a “systemic crisis.” He added that these countries need to try to contain the crisis by taking even stronger action than they already had. 

The strong words in the European Parliament were sparked by increases in the interest rates being paid by members of the eurozone which had until recently been regarded as stable. On Tuesday, the interest rates for France, Belgium, Austria, Finland and the Netherlands jumped sharply. This indicates a major loss of trust on the part of investors coupled with a wave of speculation against the eurozone as a whole. Then there is also the expectation that apart from Germany, eurozone economies will not continue to grow. Prices for credit default swaps in the eurozone also rose on Tuesday.

These act as an indicator of how interest rates for government bonds are likely to develop in the future. 

“Investors aren't confident about the eurozone's ability to solve its problems. So they are looking for the safest place to put their money. That means Germany - and so everyone else suffers,” Elwin de Groot, an analyst with the Rabobank in the Netherlands told the Reuters news agency.

Especially the Dutch government, as represented by PM Mark Rutte and Finance Minister Jan Kees de Jager, has boasted at many occasions on the stability and economic strength of The Netherlands. However, it seems that the financial markets start to understand that The Netherlands, Finland and Austria are only small countries with a (in absolute terms) small GDP and thus little financial firepower.

On top of that, Austria has a substantial exposure to Italy and the East-European countries, while The Netherlands has an extraordinarily large financial industry, extraordinarily large mortgage debt of 120% of GDP and an extraordinary dependency on exports to the other Euro-zone countries. Besides that, the Dutch economy is cooling down currently with a 0.3% decline in Q3 (QoQ); see The latest macro-data from the CBS.

I guess that the conclusion of Rabobank’s analyst Elwin de Groot is totally right; Germany is considered the only real stable factor in the Euro-zone. But even Germany’s stability will not be for eternity if the financial markets really put it to the test.

The word of today and tomorrow is and will be ‘contagion’. Contagion is eating the EU from the outside in and it won’t stop until the whole job is done. Germany seems the only stable factor now, but in the end it will only be the last domino to drop.

That is: if the EU governments don’t come up quickly with a serious Marshall plan to help the economies of the weak Euro-zone countries, in order to end the Euro-zone crisis once and for all.

Extra debt money for the PIIGS, the leveraged EFSF, the Euro-bonds or Quantitative Easing ECB-style are all feigned solutions and will only delay the problems, instead of solving them.

But this Marshall-plan asks for political courage, solidarity and benevolence that is not present in the current generation of EU leaders.

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