Spanish Debt Flu

Spanish Yields Rise After Moody's Ratings Threats

Moody's put Spain's Aa1 rating on review for downgrade, citing Madrid's high funding needs, doubts over its banking sector and concerns over regional finances.

Spanish 10-year government bond yields were 3.5 basis points higher at 5.586 percent, off earlier highs close to 6.5 percent, on small amounts of buying, traders said.

That left the spread over benchmark German Bunds at 254 basis points, although some of the pressure was due to selling ahead of a 10- and 15-year Spanish bond auction on Thursday.

"The Moody's review is hardly a surprise, and they are not citing anything which the market has not already priced in," Credit Agricole rate strategist Peter Chatwell said.

"But markets do move to a state of heightened alertness when one rating agency moves on the assumption that there are more to come."

The Moody's move followed Standard & Poor's cutting its outlook on Belgian debt to negative on Tuesday. [ID:nLDE6BD17S] A one notch Spanish downgrade would bring the Moody's rating into line with S&P's AA rating.

Spain paid dearly at a T-bill sale on Tuesday and is expected to pay a heavy premium at its longer-dated bond sale.

Chatwell said the market was building in a concession, with 10-year Spanish bond yields already more than 90 bps higher than their Italian equivalents. He added that there was room for further cheapening in a thin year-end market.

The bid/offer spread on the 10-year bonds was around 65 bps, according to Tradeweb, reflecting market illiquidity.

Madrid must pay 5 billion euros of coupons in January, 18 billion euros of coupons and redemptions in April, and around 22 billion euros in July, according to Reuters data.

Portugal, another highly-indebted peripheral euro zone state, sold 500 million euros in three-month treasury bills with borrowing costs rising sharply from the previous sale.

Comments:

Our friends in Spain and Portugal are suffering badly from sovereign debt overload. The bond market in the past few months has finally wised up to the magnitude of the debt problem. As we discussed in a previous post, Spain has huge sovereign debt rollover needs in 2011 and 2012 with 190 billion Euros of borrowing requirements in 2011 alone. At nearly 18% of Spanish GDP, this is a very serious issue.
Germany has made is very clear that they will not be funding a bailout as happened with Greece, and that they do not support Eurobonds as a solution.
How this plays out remains to be seen, but default is an option that will eventually be discussed, in my view, and that will have terrible consequences in the markets.