Europe Silent as Spain and Italy Float Away
08/04/2011 3:57 pm EST
Danger, danger, danger.
Everyone agrees that a 6% yield on a Eurozone country’s ten-year government debt is unsustainable, and that’s it’s a clear sign that a country is headed down the rescue-package route so recently traveled by Greece for the second time.
On August 2, ten-year bond yields for Spanish debt hit a high of 6.42%. For Italy, ten-year yields climbed to a high of 6.25%.
And the policy response from the Eurozone’s political and financial leaders? The sell-off of Spanish and Italian bonds is “clearly unwarranted on the basis of economic and budgetary fundamentals,” European Commission President Jose Barroso said in an e-mailed statement that day.
Good luck stopping the bears with that weapon.
Yesterday, August 3, Italy and Spanish bonds got a bit of a breather—no thanks to anybody in the Eurozone. The Swiss National Bank, trying desperately to keep the soaring Swiss franc from appreciating Swiss products out of the global market, cut its benchmark three-month rate to 0%.
With that, the yield on the Spanish ten-year bond retreated to 6.24% and the yield on the Italian ten-year fell to 6.07%. (Note that both are still above the 6% danger level.)
But don’t expect Spanish and Italian bond yields to head down significantly on either statements by Eurozone politicians or Swiss National Bank rate cuts.
And today’s announcement from the European Central Bank that it would resume buying Irish and Portuguese bonds—but doesn’t plan to intervene by buying Italian or Spanish bonds—puts the Eurozone’s central bank on the sidelines. Bank president Jean-Claude Trichet curiously chose to note that even the decision to buy Irish and Portuguese government debt wasn’t unanimous.
It’s easy to read those tea leaves...the bank is so politically divided that intervening in the Italian or Spanish crises is unlikely.
So any bond trader worth his or her Bloomberg knows that the weeks ahead present a clear opportunity to drive Eurozone bond prices down without fear of a significant response. I’d call this the Great Euro Bureaucracy Arbitrage.
You see, that great big deal that the Eurozone put together for Greece not so long ago expanded the powers of the European Financial Stability Facility to intervene in the bond market. For the first time, the EFSF can step in to buy bonds at distressed prices to stabilize markets.
This is exactly what Spanish and Italian bonds need right now—a big backstop buyer with billions in cash.
Just one little problem. The European Financial Stability Facility can’t do anything until its bureaucrats finish drafting the rules that give the full details of these new powers.
And then, still before the EFSF can do anything, the 17 Eurozone governments have to sign those rules. And then they have to be ratified in a process that in most member countries includes a parliamentary vote.
How long will that take? The optimists say weeks. The pessimists, familiar with the workings of the Eurozone bureaucracy, say months.
And in the meantime, bond traders have the run of the market, free to try to drive prices down, without fear that the European Financial Stability Facility will step in and turn their trades into losses.
As long as the European Central Bank remains on the sidelines.
Full disclosure: I don’t own shares of any stock mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own shares of any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/