Markets rally in expectation Spain will seek soft bailout

The Spanish stock market rallied and the country’s risk premium narrowed on Tuesday as expectations grew that Spain will seek a second bailout to lower its borrowing costs.

The foreign press on Tuesday quoted a senior Economy Ministry official as saying that Spain is ready to make a request for assistance from the permanent European Stability Mechanism (ESM) in the form of a precautionary credit line, but was waiting for external factors to resolve themselves such as the impact on other euro-zone countries like Italy.

A precautionary credit line could come with fewer conditions attached but would be sufficient to trigger bond purchases by the European Central Bank (ECB) in the secondary market. If that helps to sufficiently push down Spain’s risk premium, the government may not need to tap the contingency loan. “The credit line is not fundamental, it is circumstantial,” the Financial Times quoted the official as saying.

The official said the effect of asking for the credit line could in itself bring about a sharp drop in Spain’s borrowing costs. “It could be possible that the ECB does not have to buy a single bond,” the official said.

The markets were also buoyed by support from key German lawmakers for a possible bailout despite opposition from Finance Minister Wolfgang Schäuble. Any request from Spain for assistance from the ESM would require the backing of the German parliament.

“My impression is that the Spanish government is going to extreme lengths in terms of (fiscal) consolidation and extreme lengths on structural reforms,” Bloomberg quoted Michael Meister, a deputy caucus leader of Chancellor Angela Merkel’s Christian Democrat bloc, as saying. “But up to this point they have done a very good job of hiding it from the broader public.”

Merkel’s party budget spokesman, Norbert Barthle, said a precautionary credit line “would be a possible move.”

The yield on the Spanish benchmark 10-year government bond fell to 5.723 percent from 5.817 percent at Monday’s close. That helped narrow the spread with the German equivalent by 9 basis points to 425.

The yield on the two-year bond fell to 3.062 percent from 3.199 percent on Monday. ECB intervention would focus on debt with a maturity of up to three years.

The blue-chip Ibex 35 put on 3.41 percent to 7,940.20 points, leading the rest of the major European indices higher. The banks were up despite S&P’s decision to cut their ratings in the wake of the sovereign downgrade. Santander closed up 4.32 percent, while BBVA added 5.98 percent, and Banco Sabadell 4.21 percent.

Earlier on Tuesday, the Treasury surpassed its own issue target in Tuesday’s auction of short-term paper on expectations of a “soft” bailout. The government’s debt-management arm sold 4.863 billion euros in 12- and 18-month bills, compared with a target range of 3.5-4.5 billion as the rates offered fell.

Tuesday saw the first debt auction after Standard & Poor’s lowered Spain’s sovereign rating by two notches to BBB-, just one notch above junk status.

The Treasury sold 3.400 billion euros in 12-month paper at a marginal interest rate of 2.860 percent, the lowest rate since April, and down from 2.978 percent in the previous auction of one-year paper held on September 18. It issued a further 1.463 billion euros at a cut-off rate of 3.070 percent, down from 3.150 percent.

Total demand for the two legs of the auction came to 13.653 billion euros. The bid-to-cover ratio rose to 2.71 times for the 12-month issue, up from 2.03 times in September. Demand for the 18-month issue fell to 3.04 times the amount sold from 3.56 times at last month’s tender.

The Treasury has already sold 75.632 billion euros in medium- and long-term debt since the start of January, 88 percent of its target for the full year.

The average cost of debt in the period January-September was 3.39 percent, down from 3.90 percent in 2011.