Spanish Bond Sale Disappoints, European Stocks Crater

Spain's latest government bond auction managed to disappoint the markets: the volume sold was at the low end of the anticipated range and yields rose. It was by no means a catastrophic auction result (the bid to cover was at 3), but the markets are now becoming very sensitive to any hint of bad news emanating from Spain.

One thing is clear, the auction was a far cry from the scorching successes seen at the auctions following immediately on the heels of the ECB's LTRO funding rounds. It appears that Spain's banks have shot their LTRO wad, so to speak.

Euro area stock markets immediately sold off further, after 'risk assets' were already rattled by the allegedly 'too hawkish' March FOMC minutes (more on that further below).

As CNBC reports on the bond auction:


„Spain sold 2.6 billion euros ($3.4 billion) of government bonds on Wednesday, towards the lower end of its target range and at higher yields than at previous sales.

The 2020 bond on offer was sold at an average yield of 5.34 percent, with a bid cover of 3.0.

Spain also sold three and four-year debt, at yields of 2.89 and 4.32 percent respectively. Borrowing costs had been expected to rise, reflecting growing investor concern over Spain's public finances.

"The results are a far cry from the blowout auctions we saw between December and February, which will no doubt be interpreted as the LTRO bid having dried up," Peter Chatwell, Interest Rate Strategist at Credit Agricole in London said.

"There appears no problem in issuing the paper, but judging by the average yields at these auctions, demand is now much more price sensitive and a truer gauge of investor sentiment."


(emphasis added)

Looking at the chart of Spain's 10 year yield, we get the distinct impression that the trend is once again changing from down to up:



Spain's 10 year government bond yield: after testing lateral support in its post LTRO decline, it has begun heading back up with a vengeance – click chart for better resolution.



Spain's stock market looks like it is about to jump over the proverbial cliff; after building an extended bearish flag, the IBEX has begun to head down toward its previous lows quite speedily:



The IBEX is approaching the lows of 2011 quite fast now. Will they hold? We have some doubts about that Portugal ironically had a somewhat better debt auction today, in a first attempt to test the market's appetite. Yields however rose slightly anyway and it looks as though the recent better tone merely managed to produce a test of lateral support in bond yields as well. If one looks at Portugal's stock market, the true state of the country's economy is conveyed all too well – click chart for better resolution.



Portugal's 10 year government bond yield. The recent better tone can not mask the fact that the long term trend remains intact. This yield has also tested lateral support levels and appears now headed higher again, although there is still a chance that the support level will break on the next attempt – click chart for better resolution.



Portugal's stock market index has been sitting out the recent 'risk rally'. Although quite depressed already, this market continues to look technically vulnerable – click chart for better resolution.



So what about Italy? Contagion is currently less pronounced than it used to be, but that doesn't mean it has gone away entirely. While both stock markets and bond yields of the euro area's 'problem children' have begun to diverge noticeably in recent months, re-convergence seems a highly likely outcome if the market's assessment of the state of the crisis once again deteriorates. We may well be on the cusp of this point – as we have mentioned previously, even the strongest European stock market, namely Germany's, sports a chart formation that lends itself to a long term bearish interpretation.



Italy's 10 year government bond yield so far retains more of its decline, as the markets have given a temporary thumbs-up to Mario Monti's austerity budget. Also, Italian banks were among the biggest buyers of government bonds following the LTRO funding. And yet, even here we see mainly a retest of strong lateral support levels – which used to be resistance levels previously – click chart for better resolution.



The Milan stock index also looks a tad batter than its peers in Spain and Portugal, but the recent decline is beginning to look ominous, as prices have declined below both the 50 and 200 day moving averages again – click chart for better resolution.



Scott Barber at Reuters has posted an interesting chart that is comparing euro area unemployment rates over time. This shows how the European economies are locked in different cycles, which makes it impossible to

run a 'one size fits all' monetary policy. Central economic planning is of course already fated to produce what might be charitably called 'sub-optimal results' from the outset, but in the euro area it is an even more difficult than elsewhere, if not nigh impossible.



Euro area unemployment rates compared: how is the ECB supposed to set an administered interest rate that can be deemed to be the 'correct' one for all these different economies? Not even if the business cycles in these different nations were locked would it be possible for the central bank to correctly 'guess' what the natural interest rate should be. However, as things stand it is an absolute certainty that the administered interest rate rate will not even reflect the correct level by accident – click chart for better resolution.



In this context is is interesting that ECB chief Mario Draghi is said to be 'tested' now by growing wage inflation in Germany:


“Wage moderation in Germany may be coming to an end at precisely the wrong time for European Central Bank President Mario Draghi.

As nations from Greece to Spain battle recessions and record unemployment, workers in Germany are winning some of the biggest pay increases in two decades, with public service staff set to gain 6.3 percent more by the end of next year. That’s widening the gaps between Europe’s largest economy and its euro- area peers, making the ECB’s one-size-fits-all monetary policy less effective.

“While the German wage deals are good news for workers, Draghi is unlikely to be popping the champagne corks,” said Carsten Brzeski, an economist at ING Group in Brussels. “ECB policy is inappropriate for each individual country in the euro area; it’s too loose for Germany and too restrictive for the periphery. It could end up making the divergences even bigger.”

Draghi is facing the possibility of price pressures building in Germany just as they wane in nations that have been pushed into austerity drives by the sovereign debt crisis. Only months after the ECB cut its benchmark interest rate to a record low and pumped more than 1 trillion euros ($1.3 trillion) of cheap cash into Europe’s banking system to stem the crisis, Draghi warned of “upside risks” to inflation and started talking about how to withdraw the emergency measures.”


(emphasis added)

They could have just as well entitled this article 'The Impossible Task of Central Economic Planning'.


The  March FOMC Minutes as a Trigger Event

When Ben Bernanke recently delivered a speech on the labor market, we opined that 'market participants simply heard what they wanted to hear, not what was actually said'.

Bernanke didn't breathe a single word about more 'QE' – he merely reiterated what the FOMC has been telling us ad nauseam for years now, namely that monetary policy will remain loose.

Why anyone was actually surprised that the March FOMC minutes showed a temporary disinclination by FOMC members to expand the Fed's balance sheet even further is slightly mysterious.

'Fed minutes disappoint QE3 hopes', one headline read.


Fed minutes disappoint QE3 hopes. Market sentiment started to sour shortly after the NY open with a disappointing US factory orders headline (the detail was ok though) but was particularly stung by the release of the FOMC minutes a few hours later.

The number of members looking for further stimulus was downgraded from “a few” to “a couple”, and those members were conditional on growth faltering or inflation stuck below 2%. While this is consistent with the less dovish tone of the original statement on 14 March, market expectations for QE3 clearly remain high.

The S&P500 is currently down 0.7%. The CRB commodities index is 0.5% lower, oil -1.1%, copper -0.9% and gold -2.1%. US 10yr treasury yields were 2bp lower at 2.15% before the FOMC minutes, surging afterwards to 2.29%. The 2-10yr curve is 5bp steeper at 191bp. Eurozone peripherals were weaker, Portugal’s 10yr up 17bp, Greece +18bp, and Spain +10bp. Among renewed concerns, the IMF’s Weiss remarked Portugal’s commitment to reforms was unconvincing.”


(emphasis added)

Again, why was anyone surprised by this? What did people expect? That the Fed would argue in favor of more QE just as the stock market has reached new recovery highs and economic data continue to point to a recovery? The central bank is already under fire for all its money printing to date after all.

Not to worry though, 'QE3' will be back on the table in a hurry if the stock market plunges and economic data begin to deteriorate again. Just consider this year's composition of the FOMC board:



A chart from a Societe General research report, showing the distribution of votes on the FOMC board. This year the 'doves' predominate – a single 'hawk', Jeffrey Lacker has been the sole dissenter at this year's FOMC meetings thus far, whereas last year, three hawkish members (Plosser, Fisher and Kocherlakota) and one dovish member (Charles Evans) dissented on several occasions – click chart for better resolution.



It should be noted here that any pause in monetary pumping tends to immediately unleash the forces of correction in the economy again – something that is mirrored by the stock market as can be seen below:



The SPX and the Fed's stimulus programs: without monetary pumping, stocks almost immediately crater until the next round of easing is let loose. This actually shows that the entire 'recovery' is an inflationary illusion – click chart for better resolution.



We happen to believe that it is virtually certain that both economic and stock market performance will immediately deteriorate again upon the cessation of active monetary pumping. Considering the composition of the FOMC board and the proclivities of the central-planner-in-chief, we also believe that the allegedly more 'hawkish' tone of the March minutes should not be taken seriously at all.

The very moment 'risk assets' head down again with some verve and economic data begin to disappoint, the merry pranksters are sure to open the spigots wide again. After all, as Bernanke himself has stressed over and over again in his papers discussing the Great Depression and Japan's long malaise, in his opinion the major error of policymakers was in both cases that they shut off stimulus 'too early'.

Therefore, more stimulus is only a question of time. In the meantime however, the 'risk asset' markets are bound to be under pressure, as they seem extremely sensitized to any hint that monetary pumping might be 'on pause'.

This should also be good news for the dollar and very bad news for all the 'carry trade' currencies.

Finally, people would do well to keep in mind that sentiment on the stock market has recently been 'through the roof' bullish and one-sided. This rarely bodes well for the market's future performance. 


Charts by: bigcharts, stockcharts, SocGen, Scott Barber/Reuters, LPL Financial



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3 Responses to “Is A Turning Point At Hand? ‘Risk Assets’ Fall as Monetary Stimulus Hopes are Dashed”

  • Andyc:

    These maneuvers over Greece are what have pushed the markets up these last months I believe and I guess they are expecting that its Ben’s turn now, so when Ben doesn’t announce QE3, these investment bunglers…bankers I mean….get antsy, both here and in Europe, I’m thinking Ben has conveyed the idea to them…”hey why should I do it, when you guys have Spain and Portugal in the on deck circle for the next bailout driven rally?”

    Of course if this slide continues Ben will capitulate and announce QE3, after all it IS his turn to hike up to the liquor store to get the booze to refresh the punch bowl with.

    I’m guessing its a game of chicken between TPTB here and TPTB over there for the near term.

  • rogash12:

    You have Portugal 10 year Bond yield chart for Spain as well.

  • lcm:

    It seems that the ECB et al have been playing “whack-a-mole” for some time in the EMU bond markets. One week, they are supporting Italy, the next week Spain, but rarely the entire complex at once (with the exception of the LTROs). However, with Jens Weidman at the BuBa nixing PIG collateral, and the subordination of the private bond holders in the first Greek default/bond exchange, the job of keeping the bond balls in the air is becoming progressively harder.

    Given that China is still viewed in some quadrants as a potential saviour for the EMU, I’m surprised that Wen Jiabao’s recent talk about breaking the monopoly of big banks in China is not getting more coverage. One could view it from the lens that China has looked at the impact of TBTF, financialization, and political capture, and decided that is not a path that should be followed.

    However, Wen’s comments alluded to difficulty obtaining credit through “legitimate” credit channels (i.e. banks), particulary for small and medium-sized businesses. This makes me wonder if there are much bigger economic problems under the surface there, and if most Westerners have grossly overestimated China’s economic situation. I also have to wonder when China is moving to increase the amount of allowed foreign investment. Perhaps it’s just China modernizing, and working to transition to a more open economy. Or maybe it is a sign of internal funding and capital distress.

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