Hesitant Spain is afraid to pull bailout trigger

HOW quickly sentiment can change. Last week, traders were triumphantly jubilant after central banks poured liquidity into markets. If price reflects all known information, you would have thought that the world’s financial ills were cured.

This week, the focus is back on growth, or to be more specific the lack of it. Although Spain’s Ibex index recently rose above the 8,000 mark for the first time since April, concerns are mounting over the Spanish economy; liquidity alone will not buy long-term growth.

MAÑANA
Spain was given a reprieve by the now infamous determination of European Central Bank (ECB) president Mario Draghi to do “whatever it takes” to ensure the euro’s survival. The ECB’s bond-buying programme has given support to Spanish bonds. But traders are far from impressed by Spain’s complacent attitude in requesting a bailout. 10-year yields are creeping up again, rising to 5.79 per cent from September lows of 5.63 per cent.

Spain will present a draft budget and outline structural reforms on Thursday, leading to speculation that it may also announce a bailout. But over-zealous markets have been burnt by expectation in the past and should be cautious.

Spain’s economy minister Luis de Guindos cooled expectations over the weekend. In a cavalier fashion, he declared that Spain was “in no rush” to seek a bailout. After his comments, 1.5 per cent was wiped off the value of Bankia, the Spanish bank, and nearly 3 per cent from Banco de Sabadell on Monday morning.

Traders wanting to take a position on Spain will naturally focus on government debt. Good news will inevitably lead to yield compression; negative news will see yields rise further.

Another target is the banking sector, which expects to be bailed out to the tune of between €60bn (£48bn) and €100bn. On Friday, the results of stress tests performed on Spanish banks will be published. But how Spain will bail out its banks depends on when it requests financial assistance from the ECB. Alarmingly, some believe that this may not come until after regional elections on 21 October.

Spain seems reluctant to request help due to the strong conditions that will be attached. German Chancellor Angela Merkel has stated: “Conditionality is a very important point. Control and help, or control and conditions, go hand in hand.” In Spain, such “conditionality” is akin to giving up sovereignty, which the Spanish would loathe. It is therefore likely that assistance will only be requested as a last resort.

GETTING MOODY
Spain may have less time than it thinks. Moody’s downgraded Spanish debt in June, citing concerns that a bailout would “increase the country’s debt burden, which has risen dramatically”. Continuing economic weakness and reliance on a potential bailout would tip Spain’s credit rating to junk. Moody’s stated that Spain was still on review and further downgrades may come this month.

But Chris Beauchamp of IG Index is unconcerned: “Downgrades are retrospective and don’t have the effect that they used to.” Impact would be limited to institutional investors, which would be restricted from purchasing Spanish debt. David White of Spreadex believes that, in the context of the bond programme, “the ECB has shown it is prepared to act as a backstop and investors know this. Rating agencies are only playing catchup. The real risk is more political.”

Spain needs to make its intentions clear to the market very soon. If it does not, bond yields will continue to rise and Spain may need to request a bailout sooner than it would like.