The Spanish bank bail-out agreement reached over the weekend didn’t really ease fears over the ongoing euro crisis less than a week from all-important Greek elections. On the contrary, the relief rally was over when the market started trading in Europe. No more details became available via comments of policymakers. Global core bonds gradually erased opening losses and while US Treasuries ended the session not far from Friday’s closing levels, the German Bunds closed with handsome gains. German yields fell by 2-to-6.3 basis points, flattening the curve.
Also in other markets, risk-off sentiment dominated. There were no eco data of importance released and also headline news was thin, but Cyprus, SMP results and some central bankers got some attention.
Investors reacted skeptical on the bail-out package and not without reason. Once more, crucial details are missing and in this context real money investors won’t return to the Spanish bond market. The yield pick-up might have been an argument in normal times to attract investors, but in the current crisis environment with fat tail risks, there is no appetite whatsoever to hunt for yield in peripheral markets. So unless the market is convinced that the problems are fundamentally resolved both in the EMU and Spain, the latter will have difficulties to fund its financing needs.
While currently the Spanish debt situation is not unsustainable, it still might become unsustainable depending on future growth, deficits and the height of interest rates. The rise to about 6.5% yesterday of 10-year bonds is of course a negative. It now remains to be seen, whether after the bail-out, Spanish banks will still be allowed to fill the gap left by foreign investors that deserted the market. A nice theme to tackle by those who will become responsible for the oversight of the banking sector after the bail-out.
On intra-EMU bond markets the initial relief rally rapidly faded as sentiment made a turn for the worse. As feared, investors weren’t convinced by the vague Eurogroup statement on the Spanish bank bailout request. Especially the subordination issue (rescue via ESM or via EFSF) dampened enthusiasm. On top, investors are reluctant to raise the stakes ahead of this weekend’s Greek elections. The Spanish spread narrowed in the opening (10-yr yield dropped to 6% at first) but rapidly staged a U-turn. Eventually the 10-yr spread added 32 bps and is back above 500 bps (520 bps). The Italian spread followed swiftly and increased by 28 bps to 473 bps, the highest level since early January. Semi-core Belgian/Austrian/French spreads widened by 7 to 9 bps and the Finnish and Dutch spreads by 3 bps.
According to ISDA, it is unlikely that subordination of Spanish bondholders as such will trigger a credit event. Also ECB Coene mentioned this. While this might avoid volatility in the short term, it shouldn’t ease fears of bondholders of subordination and its consequences in case of default.
Cypriot FM Shiarly hinted that Cyprus will ask for a full-scale bailout package before the end of the month. “When one applies to the support mechanism you take into account all the facts including needs which may arise in coming periods. Consequently, it would be a comprehensive request covering not only circumstances and the recapitalization of banks but also future needs.” “The issue is urgent. We know the recapitalization of the banks must be completed by June 30, and there are a few days left.” Cyprus is shut out of financial markets for a year, is running deficits, has a €1.8B regulatory shortfall for second largest bank and has €2B in short-term debt maturing next year. Last year, Cyprus managed to avoid a bailout thanks to a €2.5B bilateral loan from Russia.