Mariano Rajoy of the People’s Party in Spain was confirmed the new prime minister after winning the general elections Sunday, Nov.20.
Similar to his colleagues Lucas Papademos of Greece and Mario Monti of Italy markets took little notice of him and focused instead on the worrying developments in the sovereign bond markets. They also ignored a slight beat in consumer confidence in the eurozone as economic developments start to stand in the shadow of the fixed income markets.
The Euro Stoxx 50 benchmark equity index lost 5.61 percent to close at 2,111 last Friday, extending the losses from the previous weeks. The euro currency lost a whopping 2.02 percent to close at $1.32. This marks the third straight week of heavy losses for both the euro and the Euro Stoxx as markets lose faith in politicians’ ability to solve an increasingly unsolvable crisis.
Bond Auctions Disappoint Heavily
The bond market’s enthusiasm for the new Spanish government was put to the test last Tuesday when the country successfully sold roughly 1 billion euros ($1.32 billion) in short-term debt but had to pay a heavy price for it.
The bill with a maturity of six months was sold at a yield of 5.22 percent; almost double the 3.30 percent of the previous auction in October. This result means that investors demand a heavy risk premium for holding Spanish debt, as the United States for example currently pays 0.06 percent for its six months debt obligations.
Another auction that was a big failure was Italy’s sale of 6 months paper last Thursday that priced at an even higher 6.50 percent compared to 3.53 percent at the previous auction. Investors are deserting Italian bonds in droves. Japanese news agency Nikkei reports from a large Japanese mutual fund: “A Kokusai Asset Management official said the company sold off […] bonds, amid widespread concerns about the outlook for Europe’s sovereign debt crisis to avoid hurting the value of the fund, given volatile prices of the bonds. The mutual fund operator had […] divested the fund of all its French government bonds in October and all Italian bonds in early November.”
But the most interesting development did not come from the peripheral markets, which are now widely seen as weak. Perhaps the most shocking auction failure came from the very core where Germany tried to sell 6 billion euros ($7.94 billion) in 10-year debt but only managed to sell 3.64 billion euros or 61 percent of the planned amount. Investors are unwilling to buy German debt at such low yields (1.98 percent) as they are aware of the risk transfer that is taking place from the periphery to the core.
All in all, the rise in yields will probably not be over soon according to analysts at Credit Suisse Bank: “Pressure on Italian and Spanish bond yields may get quite a lot worse even as their new governments start to deliver reforms–10-year yields spiking above 9 percent for a short period is not something one could rule out. For that matter, it’s quite possible that we will see French yields above 5 percent, and even [German bond] yields rise during this critical fiscal union debate.”
Rating Agencies Put on the Pressure
The second element that put pressure on stock markets and the euro this week was the action of the rating agencies.
Hungary was cut to junk by Moody’s last Thursday due to “the rising uncertainty surrounding the country’s ability to meet its medium-term targets for fiscal consolidation and public sector debt reduction.”
Portugal was downgraded to junk by Fitch the same day, mainly on recession concerns as well as the low likelihood of the government being able to get the budget deficit under control.
Belgium was downgraded by S&P from AA+ to AA with a negative outlook, due its financial sector concentration and banking risks.
But again the biggest worry last week did not come from the periphery but from another core country, this time France, which is at risk of losing its AAA rating. Fitch said, “France can’t absorb more shocks without undermining AAA” and “French AAA would be at risk if [the] crisis intensifies.” Moody’s added fuel to the flame by saying that higher interest on French debt and slower growth would be “negative” for the country’s rating.
Can Politicians Save the Eurozone?
With bond markets moving heavily and dragging stock markets down with them, politicians have come under increased pressure to provide a roadmap for a return to stability.
Calls for the European Central Bank (ECB) to provide support were on the rise last week, but French President Nicolas Sarkozy told reporters last Thursday that there will be no more demands on the ECB, so this option seems to be off the table for the moment.
Another road that politicians have talked about in the past and that gained traction last week is increased fiscal and political integration. At this moment, European nations are tied together economically through the ECB but don’t have a federal tax collection agency like the IRS in the United States.
Sarkozy said that the “eurozone must further integrate” and that “Europe’s future requires convergence.” Italian PM Mario Monti agreed by adding that the “EU is not a constraint for Italy” and that “Europe’s indications are in Italy’s best interest.”
These comments were well received by ECB’s executive board member Manual Paramo as he indicated in a speech given at Oxford University last Thursday that “more economic and financial integration for the euro area, with a significant transfer of sovereignty to the [monetary union] level over fiscal, structural and financial policies.”
More integration and more power for Brussels to levy federal taxes could pave the way for the so called eurobonds, bonds for the eurozone that would then be exactly like U.S. Treasurys and could smooth out the imbalances that exist between different debt markets. The eurozone’s debt to GDP ratio is only 80 percent, much lower than the U.S.’s 100 percent, but the debt is too concentrated in some weak markets. Germany’s Chancellor Angela Merkel, however, again rejected that option last Thursday as “she stands firmly against joint eurobonds.”
There are no elections next week and economic data will be light (consumer and producer prices as well as consumer confidence). The focus will once again be on bond auctions and rating agency actions, as hope never ceases that world politicians can come up with a credible plan to restore stability to the eurozone.
