Spain, France Bond Sales Take On EU Crisis

By Emma Ross-Thomas and Lukanyo Mnyanda - Dec 1, 2011 3:08 PM GMT+0700

Spain and France auction 8.25 billion euros ($11 billion) of bonds today as European efforts to strengthen the region’s firewalls against contagion failed to rein in surging borrowing costs.

Spain is selling as much as 3.75 billion euros of notes as the extra yield on its 10-year bonds compared with benchmark German bunds was at 396 basis points today. France, rated AAA, is auctioning as much as 4.5 billion euros of debt as its 10- year securities yielded 112 basis points more than comparable German debt.

“Judging by where yields are, it’s not going to be pleasant,” said Elisabeth Afseth, a fixed-income analyst with Evolution Securities Ltd. in London, referring to the Spanish auction. “If there are problems getting the full amount away or if yields are pressed to substantially higher levels, it will be bad news and will further intensify the crisis.”

The auctions will test investor confidence after the Federal Reserve, the European Central Bank and four other central banks in a globally coordinated effort yesterday cut the cost of emergency dollar funding for European banks. The central banks acted after financing costs rose following euro-area leaders’ failure to bolster the region’s rescue fund as planned.

As the crisis that began in Greece two years ago moves to the euro-area’s core, leaders are struggling to convince investors they can contain the risk and assure the euro’s survival.

Spanish Cancelation

Italy, with the second-largest public debt burden in the euro region after Greece, was forced to pay almost 8 percent to sell three-year debt on Nov. 29, the highest since 1996. The same day, Belgium paid the most in three years to sell six-month notes.

France is selling bonds due in October 2017, October 2021, April 2026, and April 2041. Spain aims to sell notes maturing in April 2015, January 2016 and January 2017.

Spain changed the securities it planned to sell at the auction, opting for longer-dated notes that already trade instead of a new benchmark three-year bond, citing market conditions. Spain’s short-term borrowing costs are approaching the levels of longer-term yields as the gap between two-year and 10-year rates narrowed last week to the least in three years.

The difference between yields for three-year and five-year notes narrowed to 10 basis points, or 0.10 percentage point, on Nov. 23, and was 35 basis points as of 7:47 a.m. London time. That’s half of where it was on Oct. 7. Greek and Portuguese short-term rates rose above long-term yields just before they sought bailouts.

Big Banks

Spain’s Treasury has already issued more than 16 billion euros each of the 2015 and 2016 bonds and more than 14 billion euros of the 2017 securities, according to data compiled by Bloomberg, making them more liquid than a new bond.

Spanish banks may also prop up the auction as Treasury data show they increased their holdings of the nation’s bonds to 142.4 billion euros in September, the highest on record, from 140.6 billion euros in August. Lenders are also increasing their dependence on the ECB, borrowing 76 billion euros in October, the most in more than a year, Bank of Spain data show.

“France and Spain both have big banks so that should help out at these auctions: typically what we hear is that they are refraining in the secondary market but they are still active in the primary market,” Kommer van Trigt, a fund manager at Robeco Groep NV in Rotterdam, said in a telephone interview.

French Auction

France decided to press ahead with the sale of bonds today, braving the market turbulence, even though it has completed its funding requirements for 2011. The extra yield demanded to lend to France for 10 years rose to as much as 204 basis points more than the German rate on Nov. 17, the widest spread since 1990. The gap was 28 basis points in April.

Euro-area finance ministers said on Nov. 29 they would seek a greater role for the International Monetary Fund and ECB to top up efforts to bolster the region’s European Financial Stability Facility rescue fund.

They agreed on a plan to guarantee up to 30 percent of bond issues from troubled governments and to develop investment vehicles that would boost the facility’s ability to intervene in primary and secondary bond markets.

Spanish Finance Minister Elena Salgado, who’s set to be replaced on Dec. 22 when Prime Minister-elect Mariano Rajoy takes charge, said the measures will create a preventive firewall as there’s no “case on the table for it to be used.”

‘Dysfunctional’ Market

“A commitment by the ECB to buy is the only solution to the crisis,” said Christoph Kind, head of asset allocation at Frankfurt Trust, which manages about $20 billion from Frankfurt.

The ECB, which started buying Italian and Spanish debt in August, is resisting pressure to step up its response to the crisis. ECB President Mario Draghi asked governments on Nov. 18 “where is the implementation” of pledges to stem contagion, and said the ECB would risk its credibility if it strayed from its main task of protecting price stability.

French 10-year bond yields rose two basis points today to 3.41 percent, compared with a high this year on Nov. 17 of 3.82 percent. Investors demanded 6.24 percent to lend to Spain for 10 years, compared with a euro-era high of 6.78 percent also on Nov. 17, the date of Spain’s last bond auction.

“The auctions are very likely to be covered,” said Gianluca Salford, a fixed income strategist at JPMorgan Chase & Co. Still, the market remains “fairly dysfunctional.”

To contact the reporters on this story: Emma Ross-Thomas in Madrid at erossthomas@bloomberg.net; Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net;

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net Daniel Tilles at dtilles@bloomberg.net