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Bad bond auction in Spain spooks (rightly) global financial markets
04/04/2012 12:53 pm EST
Spanish Prime Minister Mariano Rajoy said this morning that Spain “is facing an economic situation of extreme difficulty, I repeat, of extreme difficulty.”
That’s just in case anyone missed the disastrous results of today’s Spanish bond auction. Spain managed to sell 2.59 billion euros in bonds. That was just above the minimum target for the auction and well below the hoped for maximum of 3.5 billion euros.
As bad as the shortfall in demand was, the increase in yields investors required before buying was even worse. The yield on bonds maturing in 2020 rose to 5.338% from 5.156% at the previous auction. The yield on shorter-term bonds maturing in 2015 climbed to 2.89% from 2.44%.
In the secondary market yields on the Spanish 10-year bond climbed to 5.7%. The yield on this benchmark had fallen to a low of 4.6% in late January on hopes that the EuroZone had put the euro debt crisis behind it.
Some of Rajoy’s extreme rhetoric is political posturing. He has been trying to whip up political support for his deeply unpopular 2012 budget that would impose another 27 billion euros in budget cuts and tax increases on the struggling Spanish economy—unemployment is already near 24% in Spain--in order to reduce the country’s 2012 budget deficit to 5.3% of GDP. The alternative to this budget, Rajoy is arguing, is a Greek-style rescue plan with unknown but certainly terrible consequences for Spain.
But part of Rajoy’s rhetoric is absolutely justified. The European Central Bank and its critics had both argued that the drop in bond yields for troubled EuroZone members Spain and Italy was a temporary result of the 1 trillion euro in loans that the central bank extended to European banks in December and February. That offer certainly buttressed bank balance sheets but it didn’t solve the sovereign debt crisis in Italy, Spain, and other EuroZone countries. It merely bought time for EuroZone leaders to come up with a solution.
And now, the fear is, the time is up and there is still no solution.
The drop in yields, recent data from Spain and Italy show, was almost solely the result of banks in Spain and Italy buying bonds from their own national governments. In essence, they were taking cheap money from the European Central Bank and buying higher yielding government bonds.
But the hope that the massive lending by the European Central Bank would bring foreign investors back into the market for EuroZone government paper has been largely disappointed. And with no more money flowing into EuroZone banks from European Central Bank loans, European banks don’t have the cash to buy more sovereign debt. The result is a disappointing auction like today’s with low demand and rising yields.
As bad as the news this morning is for Spain, it may actually hurt Italy more. The Italian government faces the biggest financing burden in 2012 among any of the troubled EuroZone economies. And right now Italy is only about a quarter of the way through its 450 billion euro financing needs (new money and rolling over maturing debt) for 2012.