In Focus: Spanish bond yields Widen Sharply, Reigniting Bailout Fears
It’s becoming tougher by the day for investors to keep up with events in Europe, with the elections in Greece looming ever closer on the horizon and the debate between proponents of austerity and those advocating some kind of stimulus aimed at creating economic growth intensifying. Then a fresh round of anxiety about Spain’s deeply troubled banking sector became the last straw, precipitating a selloff in stocks and bonds not only in Spain itself, but throughout European markets.
Yields on Spanish government bonds soared to worryingly high levels, setting a new record for the last six months of 6.74%, worryingly close to the 7% level that rates in both Portugal and Ireland reached before those countries were forced to seek bailouts from their eurozone peers.
Of particular concern is the fact that the yield curve is flattening as the yields on shorter-term government securities rise more rapidly than their longer-term counterparts; that’s a signal that investors are becoming more anxious about the near-term risks of owning Spanish government debt. As seen in the chart below, the spread between the 2-year and 10-year bonds has yet to approach the record lows of last summer, but the trend is worrying.
There are some valid reasons for this investor disquiet. Greece’s problems are well documented, and have been explored here on AlphaNow in this slideshow of economic charts. Recent news events have simply fanned the flames: most recently, the governor of the Bank of Spain, Miguel Angel Fernandez Ordonez, announced he is quitting his post a month ahead of the expiry of his term, blasting his critics and debating the cost and feasibility of a bailout of BFA-Bankia. That raised new fears of how the Spanish government will go about recapitalizing Bankia, which asked for €19 billion of new funds last week. Where is that money to come from? While the European Central Bank has formally said it’s happy to provide advice, it’s unclear that it will be willing to provide backstop financing for a bailout of Bankia by allowing the latter to use Spanish government bonds as collateral for an ECB loan. Unsurprisingly, Bankia shares led both the banking sector and the Spanish market lower, plunging 8.6% yesterday.
Spain’s leaders are working frantically to find ways to control the crisis. Today, the country’s deputy prime minister, Soraya Saenz de Santamaria, will be in Washington to meet with Treasury Secretary Timothy Geithner and Christine Lagarde, head of the IMF. As the crisis appears to worsen, Spain’s benchmark IBEX 35 index plunged another 2.6%, leaving it trading at a mere 7.8 times estimated corporate earnings for the next 12 months. That may seem to make Spanish equities cheap and great value on a relative basis, but investors show few signs of viewing them as anything other than a value trap as the future remains ominously shadowed and fear and uncertainty dominate. Besides, even at their current level, Spanish stocks are still pricier than they were last year, or back in 2009, as the eurozone crisis was getting underway.
It’s clear that as the crisis once again becomes acute, investors are fleeing to investments that they consider offer a minimal chance of losing their capital. In Europe, that meant that investors dumping their holdings of Spanish and Italian government bonds flocked instead to German government securities. Yields on the two-year German government securities are effectively zero – a mere 0.002% — while yields on longer-dated bonds also hit record lows; the 10-year traded to yield a mere 1.27%. The result? The premium that investors demand for owning Spanish government securities, with all the risk attached to them, soared to its highest level since the euro made its debut more than a decade ago.
Yields on relatively “risk free” assets such as the German bund and the U.S. 10-year Treasury (the latter now yield a mere 1.619%, a 60-year low) are so depressed that a number of bond investors have publicly stated that they view them as offering little to no real value beyond that of a safe place for investors to park their cash.
All eyes are on policymakers in Madrid, Berlin, Frankfurt and Brussels – and on voters in Greece – as the world waits to see whether the spreading crisis can be contained and resolved.