By Lior Alkalay
Senior Analyst, eToro
For investors and analysts it’s abundantly clear that the Spain is in dire need of help, but the Spanish government has been loathe to ask for that help directly, so instead they’ve done it in a more roundabout manner. Earlier today, the Spanish government sent out what analysts say is their clearest plea yet to E.U. policy makers to assist in the recapitalization of Spanish banks.
Cristóbal Montoro, Spain’s budget minister, publicly acknowledged today that Spain is now perceived as a high risk by investors, and that the government no longer has access to the open markets. That statement caught analysts by surprise in view of the fact that some €2 billion in Spanish sovereign bonds is due to go on the auction block later this week. In that Mr. Montoro is correct; investors are now demanding a risk premium to hold Spanish sovereign debt, as evidenced by the basis points differential between Spain’s bonds and Germany’s bunds.
Bond yields have continued to rise ever since the government nationalized Bankia, a consortium of several savings banks, and announced that Bankia would need almost €19 billion in additional capital. While the amount is not “astronomical,” as Mr. Montoro put it, the question – and he acknowledges this as well – is where Spain will get that amount from.
Bearing that in mind, Mr. Montoro later announced that the Spanish government was endorsing a proposal for a more integrated Eurozone banking system; a confirmation say analysts that Spain is looking for help in trying to find at least that €19 billion for Bankia. Nonetheless, Mr. Montoro insists that their endorsement is not self-serving. As he sees it, with the correct procedures in place which promote a Eurozone banking union, the same guarantees would be afforded to every weak bank – not just Spain’s – regardless of where in the Eurozone they are located.
Perhaps €19 billion is not astronomical, but if Spain’s Santander bank chairman Emilio Botín’s estimate is correct, then that amount – just for Bankia – is nearly half of what the entire Spanish banking system might actually need for recapitalization. According to his analysis, all of Spain’s banks combined need about €40 billion in new capital. However, quite a few analysts say that Mr. Botín’s estimate is far too conservative and likely to be much higher.
So can we connect the dots? Given the levels of volatility and the sharp decline in the Euro, investors are clearly anxious for something more from the E.U. policy makers, but how much more?
Support levels have been broken; the Euro is close to its record lows and European equities are lower for the year, shaving off nearly all of the gains made since last October. Is that a change in trend? As I have written before, we are already in a QE-Nomics era where crises are solved with liquidity injections – money is basically governing the dynamics.
However, since late last year’s round of liquidity – the Federal Reserve’s Operation Twist, the ECB’s LTRO and the BoJ’s QE – major central banks have taken a big step back, even China’s long-awaited stimulus is nowhere to be seen. And the fire sale of risk assets and the spike of Spanish yields is the markets’ signal to policy makers that it’s out of oxygen. So what do investors want? Investors expect a full-scale Spanish bailout and until they get it they will continue to push the Euro, as well as other risk assets, lower.
Well, if there is something that the QE- Nomics era taught us with the Greek, Portuguese and Irish bailout – and of course, 2008’s massive U.S. banking sector bailout – is that once the fear of a bailout materializes, investors return to buy mode.
But what is also clear is that unless and until the markets feel that the bailout funds are sufficient to last for at least several months the Euro bulls will not return. With initial assessments standing at €40 billion, a bailout that reaches or surpasses this level will likely fulfill investor expectations and could ignite a significant recovery in risk appetite and the Euro. But as with the other bailout cases, until investors get that shot of confidence they will continue to push volatility higher and cap sentiment at bearish levels.
In the long term, of course, a Spanish bailout will eventually exceed €40 billion, and the pressure on Spanish bonds is the evidence of that – the E.U.’s 4th largest economy is not being pushed to record yields for only a €40 billion bailout. But with each subsequent bailout, markets will want proof that Spain is more reliable than Greece and significantly more determined – even more so than Ireland – to recover and demonstrate that fiscal discipline is achievable.