Spain doubts put sovereign debt close to brink of unviability

The result of the elections held on Sunday in Greece did little to buoy the European markets on Monday, despite an early rally.

While the result of the polls has cleared up some of the uncertainty over the future of the single currency — the Greeks won’t become the first nation to abandon the euro zone, at least for the moment — there was only short-lived euphoria among investors, given the growing doubts about Spain’s solvency.

Monday morning saw yet another dramatic rise of the risk premium — the spread between yields on Spanish debt and the benchmark German 10-year bund. After starting the day on 543 basis points, it fell to 529 at the start of trading before rising once more, and breaking all previous records to reach 589 before closing at 574.

The yield on the Spanish 10-year bond reached 7.139 percent on Monday, yet another new euro-era high and a critical level, given that it will, without a doubt, send borrowing costs shooting up at the Treasury’s upcoming debt auctions.

A yield above seven percent is considered unsustainable, and has already prompted bailouts in other EU economies, such as Ireland and Greece. In practical terms, Spain’s sovereign debt is on the cusp of being excluded from the markets.

Despite the fact that Europe has committed to lending 100 billion euros in order to recapitalize Spain’s banks, investors have been doing their calculations and doubt that an economy that is incapable of generating growth can pay back the debts it is running up.

If that were to happen, some kind of restructuring would be inevitable.

This would imply, by necessity, that investors end up accepting some kind of haircut on their positions, as happened in Greece in March of this year.

The Spanish bourse began the day with the enthusiasm of the other European markets off the back of the news of the victory of the pro-European New Democracy in Greece, who are likely to form a government with the socialists of Pasok. The Ibex 35 began trading with a rise of 1.9 percent, but soon descended into the red, losing 2.48 percent at one point, before hitting a minimum of 6,552.2 points. It eventually closed down 2.96 percent.

European markets also lost enthusiasm over the Greek result, driven down by uncertainty over Spain’s sovereign debt. After an initial rise of 1 percent, the London stock exchange eventually rose just 0.22 percent, while Paris gave up 0.69 percent. Frankfurt was up 0.15 percent while Milan fell 2.85 percent.

Junk status

 This week the Treasury will be putting itself to what could be a decisive test. On Tuesday it will be trying to place between 2 and 3 billion euros in 12- and 18-month paper, and on Thursday will place between 1 and 2 billion euros of two-, three- and five-year bonds.

This will be the first bond issue since ratings agency Moody’s downgraded Spain’s sovereign debt, to one step above junk bond status.