Spanish Bond Auction Fails to Inspire Risk Rally

The highly anticipated Spanish bond auctions are finally over and done with! Yesterday Spain sold ALL of the bonds that it was offering, getting a total of around 2.50 billion EUR and surpassing its target of raising 2.45 billion EUR.

Spanish 10-year bonds sold for 1.45 billion EUR at a rate of 5.743% (a bit higher than its 5.403% yield in February), while its 18-month letras sold for 1.08 billion EUR with a yield of 3.463% (lower than February’s 3.495%). Unfortunately, the mixed results failed to give news traders the volatility that they were looking for.

EUR/USD Chart

You see, EUR/USD had been trading within a tight range since the beginning of the month when traders went back to worrying over contagion risks in the euro zone. Rumors circulated that Spain maybe the next euro zone country to bite the bullet and ask for a bailout. This caused yields on longer-term bonds to spike above 6%. Take note, when Portugal and Greece asked for bailout funds, their 10-year bond yields were above 7%.

Given the direction that long-term yields were headed, it’s no surprise that the euro had a lukewarm response to the relative success of short-term bond auctions earlier this week. Despite selling more than the 3 billion EUR target worth of bills, Spain’s 10-year yields only went down from 6.156% to 5.890%. At the time,traders were more interested in 10-year bond auctions as they believed that it would be a better gauge of investor sentiment.

So why hasn’t EUR/USD broken out of its tight range despite the relatively successful long-term bond auctions?Yesterday EUR/USD spiked above the 1.3150 resistance level at the release of the report before it fell to a low near 1.3070. However, the euro managed to recover its losses as EUR/USD proceeded to head back towards the 1.3150 intraweek resistance by the end of the day.

EUR/USD Chart

A good reason for the lack of euro strength is that a successful bond auction doesn’t necessarily mean that Spain’s economic problems are resolved.

First, the Spanish banking system is still under extreme duress, as bank performance is being weighed down by property depreciation and an increase in bad loans. If this trend continues, we could see a series of bank runs, which could trigger a credit squeeze. In fact, the market bees are already buzzing with talks that Spanish banks are selling their dollar-denominated assets in order to have enough euros to cough up in case of liquidity checks.

Second, the government is still having problems keeping Spain’s debt-to-GDP ratio in check. In fact, the rise in yields began early last month when Spanish Prime Minister Mariano Rajoy said that it would not be hitting its target debt-to-GDP ratio of 4.8% and instead, would most likely come in at 5.8%.

Coupling these concerns with weak GDP forecasts (IMF expects Spain to contract by 1.8% this year) and an unemployment rate of over 23%, it’s no surprise that people are having problems taking siestas as they worry about the future of the Spanish economy.

For now the European officials can enjoy a couple of days’ worth of reprieve as traders wait for more signs of recovery or contagion in the region. But with euro traders closely watchingsupport and resistance levels in EUR/USD and other major euro pairs, it won’t take much to inspire a big move!