Monday, January 9, 2012

Just When Everybody Hoped It Would Go Away, European Fiscal Crisis Comes Roaring Back

Like a Bad Meal That Just Keeps Repeating on You

The last time we were discussing Europe new governments had taken over Italy and Spain and were supposed to, at least in the eyes of experts, have fixed things.  Not so fast.  The private markets, the ones that render judgment on the fiscal condition of those that they lend money to, are not convinced.

The yield on 10-year Italian government bonds moved up to 7.12% as investors sought higher risk premiums, returning Italian borrowing costs to levels deemed unsustainable over the longer term. At that level, the Italian government must pay 5.24 percentage points more than German yields at that maturity.

About the only way that this problem can be fixed is for the European Central Bank to step in and say that it will support Italian (and Spanish) debt.  But the ECB cannot do this, it cannot lend directly to sovereign nations.  So what the ECB is doing is buying the debt from private holders after it is issued. 

The ECB buys government bonds in the secondary market as part of its Securities Markets Program, where it intervenes in secondary bond markets to ensure depth and liquidity in dysfunctional market segments.

This won’t do it folks.  Buying the debt in the secondary markets provides liquidity but does not lower the yields.  The ECB has to buy direct at interest rates substantially lower than what the market will pay.  This will set the market, give investors confidence to buy the debt and ease at least part of the pressure on troubled countries like Spain and Italy.

So the Europeans need to change the rules.  But that would be admitting they were wrong.  No one does that.  So the near term prospects are not good.

Investors had already begun the year worried about governments' funding needs, with euro-zone governments' gross issuance for 2012 forecast to be €794 billion ($1.015 trillion), according to research by Barclays Capital.

Spain and Italy are both expected to begin their 2012 financing next week. Spain is looking to raise around €5 billion by selling shorter-dated bonds on Jan. 12, while Barclays Capital estimates Italy is looking to raise around €7.5 billion from a sale of three-year, four-year and 15-year Buoni del Tesoro Poliennali, or BTPs, on Jan. 13.

Fasten your seat belts, the ride is about to get even bumpier.

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