Spain To Bail Out Regional Governments
On Friday Spain's government announced a €15 billion 'internal bailout' package to support its regions, several of which teeter on the brink of insolvency. To widespread incredulity, the government insisted that this would not increase the government's debt. Our initial conclusion from this was that Spain's government has, or at least believes to have, very good relations with Santa Claus, who will presumably provide the funds. Failing such an intervention by the mythical gift-bearer from the North pole, we would expect that the public debt will in fact increase.
We also guessed that the government has once again done its calculations with the help of the special government abacus we have seen in action many times in recent years. It is a calculation device that only spits out politically expedient results, regardless of what actually happens in that widely shared continuum generally referred to as reality.
However, it seems the government is looking at various alternative options to fund these expenditures, ranging from redeploying lottery proceeds to the sale of publicly-owned real estate and other privatization measures, so in this case it may actually be true that the trajectory of the public debt won't be impacted by the bailout measures.
Edward Hugh (who is quoted below), notes that Spain's treasury has a war chest set aside for the bailout and that it is 'not the end of the world'.
However, the market reaction to the announcement was extremely negative, as it came at a less than propitious point in time. After all, Spain's government bond market has been under enormous pressure for quite a while already and could well be on the verge of an outright panic.
“Spain’s plan to offer cash-strapped regional administrations emergency loans leaves the Treasury with 12 billion euros ($15 billion) of additional funding needs that the government says won’t affect its borrowing plans.
The central government will tap the lottery for part of the 18 billion-euro fund for regions, leaving 12 billion euros for the Treasury to finance. While Economy Minister Luis de Guindos said yesterday that the plan won’t affect the nation’s borrowing program, economists including Jose Carlos Diez at Intermoney SA say it will be hard to sustain without selling more debt.
“Where will it come from?” said Diez, chief economist at the Madrid-based brokerage, which is Spain’s biggest bond trader. “In the end it has to add to their financing needs.”
Spain’s Cabinet approved the creation of the fund on July 13 to help regions that have lost access to markets meet debt redemptions and finance deficits. The decree states that the facility will be funded with public debt and the Treasury’s borrowing program will “incorporate the amounts” needed. Valencia, the second-most indebted region, said today it was preparing to tap the fund as it faces a liquidity squeeze.
“Unless they sell public companies, I don’t see any other way to do it without tapping the bond markets,” said Rafael Pampillon, an economics professor at Madrid’s Instituto Empresa business school. “There are no other options.”
De Guindos is already pushing for the government to privatize publicly-owned real estate, and a July 11 austerity plan included measures to sell off air, rail and maritime transport services.
Spain’s benchmark 10-year bond yield rose yesterday above the 7 percent level that prompted sovereign bailouts in euro nations including Greece, and traded at 7.24 percent as of 3:20 p.m. in Madrid. Debt maturing in 2020 issued by Catalonia, the biggest regional economy, yielded 13.24 percent, compared with 6.95 percent on similar notes issued by the central government.
De Guindos yesterday said the region’s funding mechanism won’t add more stress to the market, at a time when foreign investors are reducing their holdings of Spanish debt.
“The mechanism will be financed without the need to modify the Treasury’s calendar for debt sales so the creation of this fund won’t mean additional stress on the market,” de Guindos said in Parliament.
An official at the ministry, who asked not to be named in line with policy, said the borrowing program hadn’t changed and the 12 billion euros would come from the Treasury’s cash. She declined to comment further.
“They’ve probably got a war chest,” said Edward Hugh, an independent economist based in Barcelona who publishes research for Roubini Global Economics. “It’s a lot of money but it’s not the end of the world.”
If we are generous and take Mr. de Guindos at his word, then no additional increase in the public debt will occur, at least not in the near term (i.e., the debt auction calendar for 2012 won't be altered). However, the announcement once again served as a reminder of how the Zapatero government tricked the markets into believing it had fulfilled its deficit goals: it simply starved the regions of funding, with the result that the debt moved from one part of Spain's public balance sheet to another. After the election that brought Mariano Rajoy's administration to power, it was revealed that the deficit target had in fact been missed by a huge margin. The regional chickens had come home to roost and there they remain, roosting. It is noteworthy that Catalonia, the blunder-prone largest region, now pays 13.24% for 10 year debt. That doesn't seem sustainable, given that the central government pays 7.24% as of Friday last week, which is widely regarded as unsustainable as well – including by the government itself.
Worrisome Technical Conditions
Looking at the chart of Spain's 10 year government bond yield, we are struck by the fact that the recent back and forth around the 7% mark looks like a so-called 'running correction' (roughly speaking an upwardly slanted correction, in which one of the partial corrective waves actually manages to put in a new high above the peak of the preceding impulse wave). Moreover, it looks at though the yield is currently in a third wave up – usually the most powerful part of the trend. If the 'running correction' idea is correct, then this could become a very big move indeed. A running correction usually betrays the fact that the forces driving the market are especially strong in the direction of the main trend – and there can be little doubt as to what the main trend in Spanish yields is these days.
However, yields are also close to their channel top (see the weekly candle chart in the credit market charts update section further below), which has so far managed to contain all advances. Currently the upper rail of the weekly channel is at about 7.53%, but this increases of course with every passing day (the channel's slope is approximately 35 degrees on a linear chart).
We believe that the ECB is highly likely to intervene in the market once yields exceed the 7.5% mark, as that is the level at which previously countries in the euro area tended to apply for a bailout.
It is reasonable to expect that the euro area authorities want to avert this scenario for Spain by any means available, as there isn't even a fully funded bailout mechanism in place yet that would be able to finance Spain's government. The ESM is still in the ratification process in many countries, and even if it is ratified everywhere, its capital will be insufficient for a full-scale bailout of Spain. We believe that the currently idled 'SMP' (securities market program) will soon be revived in order to buy Spanish and Italian bonds. This could temporarily halt the advance in yields at the channel top mentioned above. However, traders and investors should watch very closely what actually happens once this point is reached: if ECB intervention fails to stop the advance in yields, then a breakout above the channel top could conceivably happen, in which case the above ruminations about the wave shape of the chart and what it implies will gain in significance.
Interestingly, the approval of the Spanish bank bailout, which was received on Friday as well did absolutely nothing to calm the market.
Meanwhile, protest have erupted on the streets across Spain last week in the wake of the Rajoy government's recent announcement of €65 billion worth in additional austerity measures. We're not quite sure what the protesters are hoping to achieve, given that the government is on the brink of insolvency. Surely the government can not go back to spending money it doesn't have. People seem to hold the erroneous belief that there is a horn of plenty hidden somewhere that could be employed to shower them with freebies, if only the government were willing make use of it. This is of course akin to believing in fairy tales – every cent the government spends it must take from someone else, either by taxation, borrowing or inflation. It has no resources of its own. The fact remains though that political pressure on Spain's government is rising.
Italy – Spain with Better PR?
Italy's yields, as is usually the case, rose in sympathy with Spain's and the ten year bond yield ended the week at just below 6.23%. As one analyst recently remarked, ''. We happen to think that the differences are more profound than that, but there can be no doubt that Italy is in deep trouble as well. As noted in the excerpt below, it is possible that Silvio Berlusconi will return to the political fray. If so, then the period of 'better PR' will be well and truly over.
Moreover, is seems increasingly likely that Italy's government will miss its deficit target this year, in spite of the recently announced additional spending cuts.
“Italy has escaped closer attention than Spain in recent weeks, but this could be due to technocratic Prime Minister Mario Monti selling its story better than the Spanish government. And markets' faith in Monti could leave whoever succeeds him in a tricky position.
Monti has said he won't seek election again, but no credible alternative to his technocratic government has yet risen from the ashes. There have even been whispers that former Prime Minister Silvio Berlusconi could return to the fray.
The government is expected to miss its deficit targets for this year and next by a growing number of analysts. Targets for 2012 and 2013 are 1.7 percent and 0.5 percent of GDP, respectively, but Marco Stringa, European economist at Deutsche Bank predicts that the figures will come in at 2.3 percent for 2012 and 1.5 percent for 2013.
The IMF raised its estimates for Italy's national debt Monday, moving it up by 2.5 percent in 2012 to 125.8 percent, and by 2.6 percent in 2013 to 126.5 percent of GDP, as it cut global growth forecasts. And more bad news came from ratings agency Moody's, which cut the credit ratings of Italian banks including Unicredit and Intesa SanPaulo on Monday, after downgrading Italy's sovereign rating last week.
Bond markets are showing an inextricable correlation between the fortunes of the two countries.
"The Italian data is as bad as Spain, the difference is that Monti's a fantastic PR man compared to the PR disaster of the Spanish government. He also has some popularity. If that is lost, then that crucially exposes Italy," Michael Gallagher, director of research at Idea Global, told CNBC's "Squawk Box Europe" Monday.
Yet there are plenty of differences between the two countries – notably Italy's industrial strength and its relatively low levels of household debt.
The markets are currently treating Italy's government bonds with more equanimity than Spain's, but the two markets remain closely linked directionally. It probably won't take much to make Italy the center of attention again. Berlusconi re-entering politics may provide the impetus, so Italians should certainly hope that he reconsiders. However, as the article excerpeted above notes, there is currently no credible candidate to succeed Mario Monti in sight . Berlusconi may therefore conclude that his chances are quite good.
ECB Plays Hardball with Greece
In other news, the ECB decided on Friday to no longer accept Greek debt as collateral until after the latest 'Troika' review has concluded. Since it is already known that Greece has once again missed all targets, one wonders in what way the review could possibly change the ECB's mind. It appears though that the move is primarily designed to put pressure on Greece's government ahead of the review in order to get it to speed up the implementation of the most recently agreed upon set of new austerity measures.
As Reuters reports:
“The European Central Bank turned up the heat on Greece on Friday ahead of a review of its bailout programme, saying it would stop accepting Greek bonds and other collateral used by Greek banks to tap ECB funding, at least until after the review.
The ECB move, which analysts said was aimed at stepping up pressure on Athens to adhere to the commitments of its EU/IMF bailout, will force Greek banks to turn to their national central bank for Emergency Liquidity Assistance (ELA) funds. Those funds will be more expensive than funds available in the ECB's regular liquidity operations.
The ECB said the collateral exclusion was due to the expiration of a temporary 35 billion euro scheme agreed with Greece and euro zone leaders whereby the ECB would continue to accept Greek bonds after they went into default earlier this year.
"The ECB will assess their potential eligibility following the conclusion of the currently ongoing review, by the European Commission in liaison with the ECB and the IMF, of the progress made by Greece under the second adjustment programme," the central bank said in a statement.
European and IMF officials are due to visit Athens next week to decide whether Athens merits another tranche of aid from its latest bailout package and analysts said the ECB move was designed to step up pressure on Greece ahead of the visit. Greek leaders this week pushed back talks to hammer out nearly 12 billion euros of austerity cuts demanded by their lenders until next week after a deal proved elusive.
"In this way the ECB could be putting pressure (on the Greek government) to bring about a positive review by the troika," Alpha Finance bank analyst Nikos Lianeris said.”
In short, this move won't cut off funding from the Greek banks. They will simply make use of the Bank of Greece's 'ELA' facility (emergency liquidity assistance), which is more costly, but will keep Greece's commercial banks going for now.
Credit Market Charts
Below is our customary update of credit market charts: CDS on various sovereign debtors and banks, bond yields, euro basis swaps and a few other charts. Charts and price scales are color coded (readers should keep the different price scales in mind when assessing 4-in-1 charts). Where necessary we have provided a legend for the color coding below the charts. Prices are as of Friday's close.
The most noteworthy move last week was of course the decisive break of Spain's 10 year government bond yield above the 7% barrier. This makes it ever more likely that Spain will have to apply for a full-scale EFSF/ESM bailout, or alternatively default on its debt at some point further down the road.
CDS on Spain are once again approaching the 600 basis point barrier. Apart from the rise in Spain's yields and CDS spreads, the week was however rather uneventful – there were only very small moves in the other indicators we follow.
We have included Nomura's leading indicator for China as well this time. Just as has recently happened with the ECRI WLI, it looks as though it is about to roll over from a third lower high. If it indeed declines again from here, this would be bad news for risk assets and the chances of a so-called 'soft landing' being engineered in China. Please note that the innocuous seeming term 'soft landing' actually signifies the expectation that the government will succeed in diverting more scarce resources toward bubble activities. Although it is widely held to be a term describing a healthy economic development, this is not really what it is.
5 year CDS on Latvia, Lithuania, Slovenia and Slovakia - click chart for better resolution.
5year CDS on Romania, Poland, the Ukraine and Estonia - click chart for better resolution.
5year CDS on Morocco, Saudi Arabia, Turkey and Bahrain - click chart for better resolution.
5year CDS on Germany (white line) , the US (orange line) and the Markit SovX Index of CDS on 19 Western European sovereigns (yellow line) - click chart for better resolution.
3 month, one year, three year and five year euro basis swaps - click chart for better resolution.
Our proprietary unweighted index of 5 year CDS on the senior debt of eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) - click chart for better resolution.
Our euro bank CDS index (white line) compared to 5 year CDS on the senior debt of Goldman Sachs (orange), Morgan Stanley (red), Citigroup (green) and Credit Suisse (yellow) - click chart for better resolution.
10 year government bond yields of Italy (bid price, generic is at 6.09%), Greece, Portugal and Spain - click chart for better resolution.
Austria's 10 year yield (green), UK gilts yield (yellow), Ireland's 9 year yield (white) and the price of the Greek 2 year note (orange – note, prior to the PSI deal break this showed the yield, not the price) - click chart for better resolution.
A chart showing global alcohol consumption; by the WHO.
Canadian versus US house prices: the bubble in Canada remains intact for now. This is the main reason why Canadian households currently have higher net worth than US households on average (via Reuters) - click chart for better resolution.
Charts by: Bloomberg, WHO, Reuters, Bigcharts
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