The Euro crisis

ECB’s Rescue Worsens Spain, Italy Maturity Crunch: Euro Credit

European Central Bank President Mario Draghi’s bid to bring down Spanish and Italian yields may spur the nations to sell more short-dated notes, swelling the debt pile that needs refinancing in the coming years.

Bloomberg,

8 August, 2012

Yields on Italian and Spanish two-year notes plunged after Draghi said on Aug. 2 the ECB may buy debt on the “short-end of the yield curve” as part of a broader crisis-fighting plan. The gap between Spain’s two-year and 10-year yields rose on Aug. 6 to the widest in at least two decades, while the spread between similar Italian securities also approached a record.
 

The average maturity of Spanish debt is the shortest since 2004 as Spain, like Italy, hasn’t issued 15- or 30-year bonds all year. As Prime Ministers Mario Monti and Mariano Rajoy fight to avoid bailouts that may threaten the euro’s survival, the ECB’s plan risks adding to pressure on the two nations’ treasuries.

“In a way what the ECB has done is making the situation worse,” said Nicola Marinelli, who oversees $160 million at Glendevon King Asset Management in London. “Focusing on the short-end is very dangerous for a country because it means that every year after this they will have to roll over a much larger percentage of their debt.”

Refinancing Mountain

The average maturity of Italy’s debt is 6.7 years, the lowest since 2005, the debt agency said in its quarterly bulletin. The target this year is to keep that average at just below seven years, according to Maria Cannata, who heads the agency. In Spain, where the 10-year benchmark bond yields 6.94 percent, the average life is 6.3 years, the lowest since 2004, data on the Treasury’s website show.

“Driving down the short-dated yields provides a little bit of comfort and encourages Spain and Italy to issue more at the short-end,” Marc Ostwald, a strategist at Monument Securities Ltd. in London, said. “The problem is that you are building up a refinancing mountain.”

Draghi said potential bond purchases, which would be coordinated with Europe’s rescue fund, would focus “on the short end of the yield curve” because “this falls squarely within the range of classical monetary policy instruments.”

Spain has already asked for a European bailout of as much as 100 billion euros ($124 billion) for its banks and Rajoy is fighting to maintain enough access to debt markets to fund the budget deficit. He opened the door to seeking more external help on Aug. 3, saying he would consider triggering Draghi’s bond- buying plan if it served “Spaniards’ best interests.”

Bank Bailout

By selling shorter-term debt, Spain has been able to issue 72 percent of the bonds it plans to sell this year. Draghi’s proposal may buy time for the government, which doesn’t face any bond redemptions until October, when it has to pay back 29 billion euros of debt.

“Spain doesn’t have to come to the bond market until October,” said Steven Major, head of fixed-income research at HSBC Holdings Plc in London. “There’s time for the government to put in place new measures.”

The ECB’s previous efforts to stabilize markets have fallen short. It bought more than 200 billion euros of debt from Greece, Ireland, Portugal, Italy and Spain, and while the initiative helped slow the ascent of yields, all bar Italy have had to seek some kind of external help.

In a renewed effort to solve the crisis, the ECB lent banks about 1 trillion euros for three years in December and February, with Spanish banks among the main beneficiaries. As loans were channeled into sovereign debt purchases, bond yields fell, and then resumed their ascent as the impact wore off.

Renewed Effort

Rates on two-year Spanish notes dropped to as low as 3.38 percent on Aug. 6, the least since May 9, from a euro-era record of 7.15 percent on July 25. That widened the difference in yield between two-year notes and 10-year bonds to 343 basis points, the most since Bloomberg began collecting the data in 1993. The yield spread was 302 basis points at 12:30 p.m. in London, compared with an average over the past five years of 167 basis points.

Spain hasn’t sold securities maturing after 2022 this year, while in the same period a year ago it sold bonds maturing in 2024, 2026, 2037 and 2041. The Treasury last issued 2041 bonds in May 2011 at an average yield of 6 percent. Those bonds yielded 7.26 percent on the secondary market today.

Italy hasn’t sold debt maturing after 2026 this year. It last sold 2040 bonds at an average yield of 5.43 percent in May 2011 and the yield is 6.48 percent in the market today.

“There is a shortening of the duration on the bonds, which increases the roll-over risk,” said Thomas Costerg, an economist at Standard Chartered Bank in London. “We don’t see what the ECB said last week as a game-changer, there are still sizable implementation risks and investors may lose patience.”