The European finance ministers met in Cyprus on Friday to discuss financial issues in the EU. One of the sticking points has been whether Spanish Prime Minister should seek ECB help by agreeing to adhere to the strict budgetary and fiscal conditions that are a prerequisite for such intervention.
If Spain refuses to seek help formally, will the rally in Spanish and Italian bonds continue? That’s a distinct possibility since it depends on the market’s perception on why Madrid may delay seeking ECB intervention, says Luca Jellineck, head of European interest-rate strategy at Credit Agricole Corporate and Investment Bank.
Spain and Italy can borrow from the primary markets at a more affordable rate now after Draghi’s unlimited bond purchase announcement. If the issue is how far they can stretch it without asking for liquidity help from the ECB or EU partners, then the current trend is likely to continue since trends are by definition self-reinforcing and involves herd behavior in the market.
However, an open and acrimonious discussion over conditionalities may reverse the trend and widen spreads, with the ECB asking for more and Madrid refusing to toe the line, he noted.
That possibility however, seems unlikely for now because, a) if you are meeting ECB targets, you are doing well enough, and b) the latest ECB approach “to do whatever it takes to save the euro” has been very successful. And success breeds consensus. Everybody, including the Germans should be very happy with the way things are moving now and they should keep it that way, Luca observed.
Does that mean Spain would resist pressures for seeking help? Well Spain is unlikely to seek help any time soon since the country has decent cash reserves now, he noted. There’s an impression that due to large redemptions due in October, Madrid may seek external help immediately. But Rajoy may extend it for a few more auctions and take it to October. If they feel the effect of ECB’s announcement has fizzled out or they wish to borrow more cheaply, then they may ask for it, he added.
Asked if a delay on the part of Spain will affect larger economies like France given the close correlation between Spanish and Italian bond yields which may eventually affect French borrowing costs, Luca said such a scenario had played out late last year/early this year when French bonds were positively correlated with the peripheries and negatively correlated with core countries like Germany. But the trend has reversed recently and countries like Belgium and France are positively correlating with Germany. Spain and Italy have also started to improve, he noted.
One of the lessons that the policymakers have learned after the 2010-11 credit crisis is that pushing countries like Portugal and Ireland into the arms of EFSF (for strict austerity measures) were counterproductive in the long run, Luca said.
Hence it is unlikely the same pressure will be put on Spain though there is some concern over things getting done. The country may be asked to bring borrowing costs down more rapidly, but they will not be intimidated into a bailout, no matter how light the conditions might be, he concluded. You can watch the video here.