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Spain embarks on tough funding tests

Source: Reuters - Fri 6th Jan 2012
Spain embarks on tough funding tests

Efforts to address the euro zone debt crisis face their first major test of 2012 at Italian and Spanish bond auctions next week which will gauge the willingness of investors to plough more money into the region's troubled sovereigns.

Both countries have an uphill struggle to convince investors they can raise enough money to pay back a mountain of maturing debt in 2012 with low growth, weak public finances and downgrade threats driving borrowing costs to unsustainable levels.

Spain will launch a new three-year bond alongside sales of two existing bonds while Italy is also expected to announce an auction of bonds maturing in 2015 and may add other lines.

The Italian and Spanish auctions will be the focus of a tightly packed supply schedule, which will also see sales next week from triple-A issuers Germany, Netherlands and Austria, expected to total more than 21 billion euros.

"The market clearly doesn't believe the last summit is a solution to the crisis. These bond will most likely get sold, but the real issue is the yield they have to pay to borrow the money," said Alan McQuaid, chief economist at Bloxham Stockbrokers in Dublin.

After a torrid start to the year, Italian bond yields stand at more than 7%, above the level at which investors abandoned Greece, Portugal and Ireland, while Spanish yields are rising back towards that danger point after a series of grim budgetary projections.

"Even though the refinancing needs for Italy are actually more pronounced, we see Spain to be under more pressure given the persistent negative news flow and two auctions over the next two weeks," said Norbert Aul, strategist at RBC Capital Markets in London.

Yields on both Italian and Spanish debt were seen climbing early next week in the run-up to the sales, extending a rise of 27 and 61 basis points on the countries' respective 10-year bond yields this year.

Demand for the debt was likely to come from domestic banks which traditionally provide much of the bidding for Italian and Spanish bonds, analysts said, with longer-term investors such as pension and insurance funds still expected to steer clear.

A huge surplus of cash injected into the banking sector by the European Central Bank has also spurred some demand for shorter maturity peripheral debt, tempering the rise in yields at the short end of the Spanish and Italian curves.


Despite offering rock bottom yields, German and Dutch bonds were likely to benefit from the move into safe and liquid assets, but fellow triple-a rated issuer Austria faced a more difficult test of sentiment, analysts said.

Austrian 10-year bond yields have risen by a whopping 40 bps since the start of the year as neighbouring Hungary has descended into crisis and sparked concerns over Austria's banking sector exposure to its neighbour.

That makes for a tough backdrop to Vienna's planned sale of 1.32 billion euros of debt, split between 2016 and 2022 bonds.

"We've seen very sizeable concession across the curve but certainly in the 4-6 year sector...That should support at least the shorter dated of the two sales," said Rabobank strategist Richard McGuire.

"But, clearly the uncertainty surrounding the Hungarian situation is a negative and so the possibility of a poor result is by no means insignificant."

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