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Ad Hoc Commentary

Thursday June 14th 2012

Thursday, June 14th 2012
Status de basura y un paria financiera  ~  Junk status and a financial pariah
Sometimes, the commentary from Spotlight may be seen as flippant, we know we cannot please everyone, but sometimes we need a little levity to lighten the mood. But that may be "Gallows Humour" as here and now the single currency dream  that has shaped European economic policy since the Maastricht Treaty was signed on February 7th 1992 is staring into the abyss.
Moody's Investor Services has downgraded the Kingdom of Spain by 3 notches pointing to 3 problematic issues:
  1. An increased debt burden
  2. A rapidly deteriorating economy
  3. Restricted access to the international capital markets
The sovereign rating is now Baa3 down from A3 and it has been placed on negative watch as the bank bailout plan will see EUR100Bn accessed from the rescue funds that are administered by the Euro Zone. For weeks the level of bluster and bravado from the Spanish government begged the markets to believe that the Kingdom could finance a rescue of the banks on its own. Just as Spain was never going to meet a deficit to GDP ratio of 5.3% this year so attending to the loss baring lenders was simply not on the cards. The past weekend's request for help whilst pragmatic was not a sign of strength...it is weakness ... it was panic,  seeking to secure funding secured before the Greek election could derail the whole operation.
Is there anyone still in the house that believes Spain is not going to have to request a full bailout? If one denied the bank aid was a bailout, that position now stands indefensible.
Not so "Magnificent Seven"
The level of
The intraday chart on Wednesday had Spain's 10 year yield peaking at 6.779% before settling at 6.754% at the European close.  As we open on Thursday 6.884% has printed. The spread over Germany closed at +529bps...just shy of the +536bps on June 1st. The market is going to look for ECB action to stem the rising yield tide, however, is that not just throwing good money after bad. At 07:25 in London the spread is +541bps.
The pathway is clear, unless there is intervention, then the course of least resistance is for yields to rise higher and 7.000% is just the first target.
Where next?
We have applied an extension forecast model to the Spanish 10 year yield and spread over Germany. We conclude that in the absence of any ECB support...and not just another LTRO side door injection of funds but a full bond buying programme we see the following:
  • Spain 10 Year Yield:   Close June 13th 6.754%. Once 7% breached an acceleration to 7.184% and then 7.453%. (Higher figures can be given)
  • Spread of 10 Year Spain over Germany:   Close June 13th +529bps. Once +536bps broken this will target +589bps.
 debt to GDP for Spain will sky rocket from 36% in 2007 to in excess of 90% this year. We are actually surprised to see that Moody's stopped one level above junk status. Maybe to go the whole step would have been too much in one go but we fully expect to see that status achieved when Moody’s completes a detailed rating review on Spain by the end of September. 

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