Wednesday, 26 September 2012

Snatching default from the jaws of victory?

After the ECB had successfully cast the issue of eurozone convertibility risk into the annuls of history, Europe’s politicians seem set to resurrect it.

Under intense pressure from the Catalonian separatists, Spain’s PM Rajoy has been resisting the temptation to request a formal bailout. That course of action makes sense while secondary market conditions continue improving, even though it was always almost inevitable that the favourable terms of a bailout would be needed.

Spain’s borrowing costs rose in the primary market at yesterday’s auction; a move which should signal that the secondary market train has run its course. Thereafter it was time for Spain to ask for help, the ESM to provide it and the ECB to make a credible stance in the secondary market. Crushingly, instead we had a bizarre statement from Spain’s Deputy Prime Minister that the government would not ask for help until they knew how much the ECB planned to spend in its OMT programme. In true jeopardy style the answer to the question had been delivered weeks before Ms Sáenz de Santamaría had even asked it. Back in July Mr Draghi promised to do whatever it takes.  As long as the market believes that then it will have to do very little. Potential beneficiaries questioning it, however, are a red rag to the speculative bull. 

Compounding those loose lips was apparent back-pedalling by the Finnish, German and Dutch finance ministers over the ESM funding of the Spanish bank recapitalisation. Whilst their statement does not specifically call into question the existing agreement, that severed the link between the Spanish sovereign and its banking liabilities, uncertainty resounds about how firm that agreement is. This is incredibly frustrating as the deal formed one of the pillars of the eurozone revival (specifically one we have been waiting for since September 2011– the sooner the creditor countries recommit themselves to the deal the better.

All of which has put Spain under an increasing pressure in the bond markets - pressure which is being compounded by political considerations. Readers of the Week In Review will remember the Catalonia Independence Parade from a fortnight ago. Now these separatists have raised their voice louder still, as the region’s president has announced snap elections which will be fought on the issue of whether or not to remain subservient to the national government in Madrid.

The market has cast its vote early with Spanish yields soaring back towards 6%, levels last seen in early September. Now is unquestionably the right time for Spain to request a bailout, and for Germany, Holland and Finland to join with their European cousins in providing it. Convertibility risk is back and must be vanquished once more…

Guy Foster
Head of Portfolio Strategy

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