Spain Or Italy: Who’s Going Down First?

Uh oh, Italian and Spanish bond yields are on the rise! If you’ve gone through the School of Pipsology, you probably know that this is bad news. Rising yields could imply that investors are not confident that these countries could pay back their debts, also making borrowing costs for Italy and Spain more expensive.

Now, market junkies are worried that as the positive effect of the ECB’s 3-year LTRO (long-term refinancing operation) program wanes, the Troika might soon need to pull off a dramatic save on at least one of the two debt-ridden countries.

Spanish vs Italian Bond Yields

As you can see, Spain’s borrowing costs ranged between 5.0% and 5.5% early on in the year while those of Italy steadily declined from over 7.0% and bottomed out just below 5.0%. Positive developments between euro zone leaders helped keep interest rates from skyrocketing. However, many economic gurus believe that borrowing costs only really steadied following the ECB’s announcement of its LTRO plan. For those of you who don’t remember, the central bank launched a liquidity program in February to help European banks pay for their maturing debt.

At a glance, with Spanish bond yields rising faster, it’s easy to say that the land of matadors and flamenco is in deeper trouble than its pasta-loving counterpart.

Of course, it also helps that recent Italian bond auctions have gone without a glitch. Pip Diddy has reported that the country was able to meet-and even top-its targeted demand in its past two auctions. On the other hand, we saw dismal results in Spain’s April 4 auction in which the government barely raised enough money to hit its minimum target at 2.6 billion EUR. Ay caramba!

Italian Prime Minister Mario Monti has also restored some credibility to the country. Sure, some say that impressing investors wasn’t so hard to do following Silvio Berlusconi‘s scandal-filled regime. However, as I have pointed out in February, we can’t discount the fact that Italian bond yields started to fall shortly after Mario Monti was sworn into office.

The Spanish government under Prime Minister Mariano Rajoy has yet to be commended though, especially after he downwardly revised the country’s debt-to-GDP ratio target for 2012 from 8.5% last year to 5.3% on March 12. Heck, some market junkies even blame him for the recent rise in Spanish bond yields!

But let’s not get too excited over Italy just yet. A closer look at some of the statistics reveals that the two countries may only be neck-and-neck in trouble.

Just like Spain, Italy has vowed to implement more austerity measures amid slowing growth. The Spanish economy is already anticipated to shrink by more than 1.7% and the most recent addition of 27 billion EUR worth of austerity cuts could only choke growth even more.

Italy is in an even worse situation because it is already in a recession. Its GDP printed at -0.7% in Q4 2011 to follow its -0.3% reading for the third quarter. Consequently, this has gotten market junkies are bracing for further contraction of up to 1.3% for the economy this year as the government continues to implement its austerity measures amounting to 20 billion EUR.

Last, and certainly not the least, Italy has a much bigger need for refinancing. It needs to generate about 87.8 billion EUR for the second quarter of 2012 alone. That’s almost twice the 44.3 billion EUR that Spain has to raise. Mama mia!

With the third and fourth largest euro zone countries plagued with these concerns, it’s no surprise that talks of contagion have gone back in vogue. For some naysayers, there is no question that at least one of the two countries will soon ask for a bailout. The question is, “who will go first?”

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