Spanish and German government bonds are signaling the respite in the euro-region’s debt crisis created by the European Central Bank’s unlimited three-year loans is coming to an end.
Two weeks after Italian Prime Minister Mario Monti said the “flames of crisis” are unlikely to return, German bund yields have fallen to records and Spanish borrowing costs have surged to the highest since the ECB started its longer-term refinancing operations in December. Spanish 10-year yields rose above 6 percent this week, getting closer to the 7 percent level that triggered the bailouts of Greece and Portugal, as Prime Minister Mariano Rajoy said the country’s future is on the line.
“The positive effect of LTRO operations is now well on the wane,” said Lyn Graham-Taylor, a fixed-income strategist at Rabobank International in London. “We are well and truly back in crisis mode.”
Spain’s 10-year rates reached 6.02 percent on April 11, a level last seen on Dec. 12, having climbed from this year’s low of 4.83 percent on March 1. They were little changed today at 5.82 percent at 8:40 a.m. London time. Similar-maturity Italian 10-year yields are 5.41 percent, up from as low as 4.68 percent on March 9.
Two-year German note yields dropped to a record 0.091 percent on April 10 as investors sought the safest securities. Five-year rates declined to an all-time low 0.617 percent that day and benchmark 10-year bund yields fell to 1.639 percent, approaching the record 1.636 percent set on Sept. 23.
The ECB, led by President Mario Draghi, lent euro-area banks more than 1 trillion euros ($1.32 trillion) at an interest rate of 1 percent in its two LTROs: the first on Dec. 22 and the second on Feb. 29. Banks are said to have used the funds to buy bonds issued by the so-called peripheral nations such as Spain, Italy and Portugal.
Spanish bonds maturing in a year or more returned 6.7 percent between the ECB announcing its loan program on Dec. 8 and Monti’s speech in Tokyo on March 28, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Italian and Portuguese securities both gained 14 percent in the same period, the indexes show.
Spain’s bonds have since slumped 2.8 percent, Italian debt lost 1.7 percent and Portugal’s government securities declined 3.7 percent.
“The LTRO momentum is increasingly fading,” said Michael Leister, a fixed-income strategist at DZ Bank AG in Frankfurt. “Spreads over bunds are widening and peripheral curves bear flattening. The speed of the decline hasn’t surprised me, but rather that the market had been so complacent before.”
Bear flattening refers to a situation where short-term yields increase at a faster rate than longer-term securities, reducing the slope of the so-called yield curve.
The extra yield investors demand to hold benchmark Spanish securities instead of German bunds expanded to 437 basis points on April 11, the widest since Nov. 28. The gap widened three basis points today to 406 basis points.
“A spread of more than 400 basis points is obviously a problem,” assuming it persists in the medium term, Spanish Economy Minister Luis de Guindos said in Barcelona on April 11. “The government needs to put the house in order because the alternative is much worse.”
Italy’s 10-year yield spread over bunds increased to as much as 409 basis points on April 11 from 276 on March 16. It was at 365 basis points today.
Some strategists predict the increase in Spanish and Italian bond yields will spur the ECB to announce a third round of loans or additional bond purchases to help contain the regional debt crisis.
“We have the ECB and they’ve done a great job in securing bank funding for three years,” Francesco Garzarelli, co-head of global macro markets research at Goldman Sachs Group Inc. in London, said yesterday in a Bloomberg Television interview with Sara Eisen. “That has broken the link between sovereign and bank funding to a large extent. Spain has disappointed markets in March. It got some pressures. If these pressures escalate and percolate to other countries, I would think the ECB would step in at that point.”
ECB Executive Board member Benoit Coeure signaled on April 11 that the central bank may revive its bond-purchase program to reduce Spanish borrowing costs.
“Will the ECB intervene?” Coeure said in Paris on April 11. “We have an instrument, the Securities Markets Program, which hasn’t been used recently but it still exists.”
The ECB hasn’t purchased sovereign debt for four weeks, according to the most recent data on its Securities Markets Program released April 5.
“It’s very uncertain as to what the ultimate endgame for the peripherals is at the moment,” said Edward Thomas, who helps oversee $6 billion as head of fixed income at Quantum Global Wealth Management, based in Zug, Switzerland. “Even if yields were 100 basis points higher than they are now, we would not be looking to invest in Italian or Spanish debt.”
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