Market Overview

Spain and France's Bond Auctions Not As Successful As Reported

Despite getting bad publicity from Moody's Investors Service recently, France and Spain both conducted bond auctions on Thursday that the two countries deemed successful. Earlier this week Spain was downgraded and France was put on downgrade watch by Moody's but the two Eurozone countries managed to sell a combined 14.2 billion euros ($18.5 billion) worth of bonds on Thursday.

Despite growing concerns that Greece might fail to reach a deal with its creditors, demand for the bond auction was quite strong. Spanish Economy Minister Luis de Guindos said that the strong demand for Spanish debt was a sign of confidence in the Spanish economy. However, a closer look makes the results of the debt auction seem a bit more murky.

While demand was strong, yields on Spanish bonds actually climbed higher. This means that Spain's borrowing costs are rising because investors are demanding higher rates in order to assume the risk of holding Spanish debt.

Another thing to consider is that much of the demand for Spanish and French bonds comes from the European Central Bank's (ECB) current policy of supporting troubled European banks that have had trouble obtaining funding. The ECB pumped nearly 500 billion euros into the European banking sector by offering cheap loans to banks. The banks have used much of that money to buy the debt of countries like France and Spain.

Without this market intervention from the European Central Bank, demand for Spanish debt would have been weaker and Spain's borrowing costs would have risen even higher. Spain is taking advantage of the European Central Bank's cheap loans to the banking sector by issuing a large portion of its debt during auctions early in the year while there's still a good deal of liquidity in the market.

Spain's economy is also in bad shape and might have already fallen into recession for the second time in just two years. Recently released data revealed that the Spanish economy contracted 0.3 percent during the last quarter of 2011. The Spanish economy is also widely expected to shrink during the first quarter of 2012.

The French economy is doing better than Spain's and even managed to grow during the fourth quarter of 2011 despite widely held expectations that it would shrink. The fact that France's economy is doing better than expected and that the country hasn't been downgraded yet probably played a part in the yield on French bonds not climbing higher the way Spanish bonds did.

News that both Spain and France were easily able to raise funds during their latest auctions could be seen as a positive sign, considering the current economic environment and the fact that another troubled country, Greece, is on the verge of a possible default. However, investors need to remember that demand for these two countries' debt is artificially high because of the actions of the European Central Bank.


ACTION ITEMS:

Bullish:
Traders who believe that today's successful bond auctions by Spain and France are a sign of market confidence might want to consider the following trades:
  • Traders who foresee a a strengthening euro and healthier Eurozone economies might want to consider the CurrencyShares Euro Trust (NYSE: FXE) and the iShares S&P Europe 350 Index (NYSE: IEV) ETFs. If Eurozone countries like France and Spain can improve their fiscal health, the euro and European stocks could both move higher.
Bearish:
Traders who believe that the artificially strong demand for French and Spanish debt is cause for concern may consider alternative positions:
  • Short European financial stocks. Recent decisions by some European regulators to lift their bans on the short selling of financial stocks present an opportunity for traders who believe that the economic situation in Europe will get worse before it gets better.
  • The euro can also be shorted through an ETF like the ProShares UltraShort Euro (NYSE: EUO). Once the effects of the European Central Bank's efforts begin to fade, troubled Eurozone countries like Spain, France and Italy could see their borrowing costs soar, while the euro weakens.
Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.

Posted-In: Long Ideas News Sector ETFs Bonds Short Ideas Specialty ETFs Financing Currency ETFs Best of Benzinga

 

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