Spanish Yields Rise at Auction, 10-Year Bonds Reach Another Record High

Spanish yields rose at auction Tuesday, driving yields on benchmark 10-year bonds to euro-era highs for a second straight day. At one point, yields on benchmark 5-year bonds were actually higher than those of the 10-year bonds.

Spain auctioned bonds of both the 3- and 6-month maturity Tuesday. Spain sold 1.628 billion euros of 3-month Letras (the name for the bills) at 2.434 percent, higher than the previous auction's yield of 2.362 percent. The bid-to-cover of the 3-month Letras rose to 2.94 from 2.6. Spain also auctioned 1.46 billion euros of 6-month Letras at yields of 3.691 percent from 3.237 percent at the last auction and also with a stronger bid-to-cover ratio of 3.02 vs. 2.82.

The rise in yields reflects the fear over Spain needing a full scale bailout. As debt levels increase due to the bailouts of the banks and the regional governments on top of newly announced spending cuts, Spain may force itself into a full scale bailout. These fears have seen benchmark bond yields rise to record highs.

The benchmark 10-year bond yield rose as high as 7.625 percent, a euro-era record for Spanish bonds. Further, 5-year bonds rose as high as 7.649 percent and traded above the 10-year bond as of writing. The inversion of the Spanish yield curve on the long end is interesting; yield curve inversion has historically signaled that a country is about to enter recession. However, Spain is already in a recession and debt markets are being skewed by fear.

The inversion of the yield curve could be signaling that growth prospects in 10-years look better than growth prospects in 5-years. Also, it could simply be that traders are realizing that there is a basis trade to be made in the 5-year bonds, as 5-year CDS are benchmark swaps. Thus, there could have been a large purchase of 5-year Spanish CDS and sale of 5-year Spanish bonds. Or, the market could be signaling that Spain is about to be closed out of sovereign debt markets as short term yields rise too high to make borrowing economically sensible.

Higher yields are not good for Spanish bank who loaded up on Spanish debt after the LTRO's. Those banks include Banco Santander SAN and BBVA BBVA. Further, as regional finances deteriorate further and the capital nationalizes regional debts, BBVA may be at risk. As Alberto Gallo of RBS said on Bloomberg, BBVA is more exposed to regional finances than the other large banks. He also said he expects another round of downgrades for Spain and Italy by the big three rating agencies in the next three to six months.