Weekly Bond Yield developments in the Euro Area (W13.2012): Spain and EFSF/ESM reform – But what about Italy?

Once again, please find below the most recent developments in selected Euro-Zone sovereign bond markets. You may notice that there’s a change from previous versions. For the sake of facilitating the comparison across  maturities these are all presented in the same graphs. Moreover, instead of focusing only on the last week, a choice has been made to show movements over the last month as well as over the last 5 years, for the sake of context.

Having temporarily settled the situation in Greece, markets have made inroads towards Spain, Ireland and Portugal. Little news and much noise about these countries, as well as EFSF negotiations, dominated the news during the last week.

Portugal remains, together with Greece, a contender for a further bailout, while Ireland has needed to restructure some of its debt. Despite the LTROs, Spain has been under pressure since March 20, possibly due to exaggerated reactions to poor deficit figures and targets. These have inflicted a damaging blow to the confidence of the country at a failed sovereign bill auction. FT Alphaville has a very interesting discussion of these issues. This led the markets to speculate about whether Spain should apply for an EFSF backed adjustment programme. In parallel, EU leaders have been negotiating an expansion of the rescue fund, the EFSF/ESM, in order to ensure they possess the tools necessary to deal with whatever markets and the periphery might through at them. The core, of course, led by Germany, has been reluctant to expand the fund and so a new compromise has emerged where the EFSF and ESM would both run side by side for some time, rather than the latter replacing the first. In so doing their joint “fire power” would be larger, while giving Germany an institutional arrangement that is not uncomfortably large and permanent.

However, I find it most interesting that no one has focused on Italian yields. While the media and officials are in a frenzy about Spain, no one has noticed that most Italian yields are higher than their Spanish equivalents. The figure below provides a comparison of Spanish and Italian sovereign bond yields by maturity as of 09:08 on Monday, April 2.

Surely, if this level of yields is “dangerous” for Spain it is similarly “dangerous” for Italy. Clearly Mr Rajoy as a true newly elected official has begun his term on the wrong foot, by “unilaterally” changing the targets for the Spanish deficit, thus drawing “unfortunate attention to a fundamental weakness in the EU’s new rules to reinforce fiscal discipline: their pettiness”. Clearly, Spanish banks are not in good shape. But this is not new. Spanish banks have been in bad shape for at least 3 or 4 years. So may be it’s time to calm down and stop exaggerating the market’s reaction to Spain.

The conclusion is that the problem is either very overrated or very underrated. Either the imminent “danger” to Spain only lives inside inverted brackets or it is much bigger than has been considered and actually affects Italy. In time we will know.

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Previous weeks:

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