Warning lights flash red over Spain

Os copio el articulillo del FT, da cierto miedo.

The market warning lights are flashing red. Spain is approaching the point that saw Greece, Ireland and Portugal inexorably slip towards international bailouts.

Athens, Dublin and Lisbon lasted just 12, 24 and 34 days after the premium they pay to borrow over Germany reached 500 basis points before seeking international help. Spain hit 500bp on Monday.

Spanish 10-year bond yields, which move inversely to prices, rose to 6.5 per cent, drifting closer to the 7 per cent level seen by many as unsustainable. The move has left many in the markets thinking that some kind of international bailout is inevitable.

It is hard to know what they can do without some kind of international body coming in and giving help,” says Keith Wade, chief economist at Schroders, the UK fund manager. “Once it gets to a certain point there doesn’t seem to be a point of return.”

In a further worrying sign, while Spanish yields fell slightly on Tuesday, two-year yields shot up. The difference between the two maturities hit its low point of the year at just 185bp, down from 299bp two months ago. That is disturbing because domestic banks, fuelled by cheap loans from the European Central Bank, were at least managing to keep the short end of the yield curve under control.

“It does feel like things are coming to a crunch,” says Jim Leaviss, head of retail fixed income at M&G, one of Europe’s largest fund managers. But he adds there are no immediate signs of capitulation, noting that the spread between two- and 10-year bonds is still positive and at a similar level to Italy’s: “You are still getting a term premium for risk.”

The latest escalation in Spain’s troubles has been provoked by Bankia, the lender that needed a €19bn government rescue.

Any thought that markets would welcome the bank’s nationalisation were scotched when Spain suggested over the weekend it could sidestep the rising cost of borrowing in the bond markets by swapping government bonds directly for equity in BFA, Bankia’s parent. The bank could then deposit the bonds with the ECB in exchange for cash. That led many investors to believe that Spain was running out of ideas to solve the problem by itself.

Mariano Rajoy, Spain’s prime minister, insisted on Monday that the country did not need an international bailout. But investors see it very differently.

“Spain’s funding costs are becoming penal: something needs to get done. We need something from the European Union, but they have some time to decide exactly what,” says Shahid Ikram, chief investment officer in the UK for Aviva Investors. He suggests a European Union-wide guarantee scheme for bank deposits could help in the short term.

International assistance could take a variety of forms in addition to the deposit scheme. Greece, Ireland and Portugal were all bailed out at the government level, not least because of the weight of their debt burdens. But Spain’s public debt-to-GDP ratio is lower than in those countries. Moreover, it has already issued debt for more than half its financing needs for this year.

Funding costs are becoming penal: something needs to get done
- Shahid Ikram, Aviva Investors

Some investors, though, point out that Spain has shied away from issuing long-term debt or indeed any bonds in great size in recent months, and fret that the average maturity of its bonds is decreasing. “Some kind of restructuring on the government debt side looks like it will be needed,” says Mr Wade.

A different form of international help would be for Spain to receive money to recapitalise its banks. Analyst estimates for the amount needed range from about €50bn to €100bn. Mr Rajoy, while resisting an international bailout, has called for the region’s upcoming rescue vehicle – the European Stability Mechanism – to be able to recapitalise banks directly. That would avoid the debt going on government books.

Even with the banks, some in the market argue that while things look bad for Spain it does still have weapons in its armoury to stop the need for a bailout. Mr Leaviss says that banks could wipe out their shareholders and convert their debt into equity but that is resisted by policy makers across the eurozone.

He also underlines how the ECB could lessen the need for a bailout, at least in the short term, by doing one of three forms of policy it has used in previous stages of the crisis: buying bonds directly, giving banks cheap loans, or cutting interest rates.

Many in the market, however, remain deeply pessimistic. “It is increasingly clear that Spain needs international assistance,” says Marc Chandler, global currency strategist at Brown Brothers Harriman. He refers to Mr Rajoy’s three noes: on allowing a bank or region to fail, and on seeking international help.

Mr Chandler adds: “Something has to give and the international assistance seems to be the most likely to yield in the face of political and economic reality.”

Additional reporting by Robin Wigglesworth