EUR and Potential Impact of Spanish Bond Redemptions

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This week, Spain must pay back 20 billion euros, the single largest month of bond redemptions this year but based on the recent price action of Spanish 10 year bonds and the EUR/USD, investors don’t appear to be worried that Spain will have any problems meeting their funding obligations. According to the Spanish government, they are fully funded until the end of this year and the country hasn’t had any major problems attracting demand at recent auctions. Spain has been spared a junk rating from Moody’s, which will make it easier for the country to solicit funds. Outside of the slide in stocks, the markets have been unusually calm ahead of an extremely busy week for Spain and the Eurozone as a whole. While the U.S. non-farm payrolls report is the data that investors will be watching most closely this week, Spanish third quarter GDP, Italian, French and German bond auctions could also be big market movers for the EUR/USD.

Despite the high level of debt in the Eurozone, most of the larger countries have not had major problems raising funds. There have been cases where higher yields were paid, but bid to cover ratios have been sufficient. As a result, we don’t expect any major shortfalls at upcoming auctions and there is every reason to believe that the bonds being redeemed in Spain this week will also be reinvested. The European Central Bank’s Outright Monetary Transactions program and more specifically their pledge to provide unlimited support for the Eurozone has been the given credit for stabilizing bond yields and reducing the liquidity concerns of highly indebted nations. This week, the ECB’s report on bank borrowing rates and lending standards (due on October 31st) will shed light on the influence of OMT. While the program can’t be activated until a country like Spain asks for help, if the ECB’s report shows improved banking behavior, we will know that OMT provided a psychological boost to banks.

However, Spanish GDP numbers will remind us of the major economic difficulties faced by the Eurozone’s fourth largest economy. Spain is still openly considering a bailout and there is a good possibility that they will eventually accept one. This year’s funding needs may be completely addressed but next year Spain’s redemptions and borrowing needs will increase. The first test will be January’s 19 billion euro refinancing hump. The increasing need for additional funds only adds pressure on Spain to accept a bailout. While Spain has publicly denied the need for aid, many officials are saying that behind the scenes, talks about what a bailout program would look like are underway. Most likely, the program will include one large package for Spain, Greece and Cyprus that European leaders can take to parliament instead of 3 separate aid requests. However with regional elections in Catalonia scheduled for late November, Spain may not ask for a bailout until the elections are over.

For the FX markets, more delays means prolonged uncertainty for the euro. There’s no quick fix for Europe’s problems and even though this week’s European bond auctions and Spanish bond redemption may pass smoothly, the stability will be a mere illusion. Spain is in a state of denial about its problems and while current borrowing costs are more manageable, they need to drop below 5% to remove the need for a bailout. Aside from the uptake of bonds at this week’s auctions, incoming European economic data will also play a role in the intensification of Europe’s problem and the trend of the EUR/USD. A number of German economic reports are scheduled for release this week and deteriorating economic conditions in the region’s largest economy could also raise concerns about growth in the rest of the region.

Kathy Lien
Managing Director

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