Spanish 10-Year Falls on Possible ECB Intervention
Earlier this morning, Spanish 10-year bond yields hit euro-area highs for the second day in a row, barely staying below the dreaded 7% level. The 7% level is significant as it suggests the need for a bailout. When the 10-year yields of Greece, Portugal, and Ireland hit that level they all needed a full-scale bailout. Thus far, Spain has only agreed upon loose terms for a bank recapitalization plan.
As the bonds sold off and yields spiked, it may have been that the European Central Bank stepped in and bought bonds this morning. The Securities Market Program, commonly known as the SMP, was created to do just this. Since touching the euro-area highs, Spanish yields have come down, with the moves downward being rather large and rapid. They may suggest that the ECB could have reactivated the SMP for the first time since last year.
As shown in the chart below, Spanish 10-year yields and Italian 10-year yields were climbing to new highs until the point where the ECB may have stepped in. Italian bond yields fell from 6.345% to 6.123% in about five hours, which is an extremely large move. Further, consider the magnitude of the drops in yields on the chart. Each leg down was large, as opposed to a smooth decline, signaling that there was probably one large buyer buying sizable lots. The only institution willing and able to take positions in these securities of this size is the ECB.
If the buyer was not the ECB, the move might be even more interesting. If some institution was making a sizable bet on Spanish and Italian paper, that institution could be exposed to a blow-up like MF Global last year. Regardless, this could be the turning point for the ECB to become the lender of last resort, which may calm markets. If the ECB takes this role, it could verbally backstop the banks by saying that it was willing to stand behind financial institutions in Europe. That might be a big step forward in finding a solution to the European Debt Crisis.
Of course, there are downsides to ECB intervention. First, it is a temporary solution, not a cure. The last few times the ECB bought bonds, yields fell only to resume their climb over the next several weeks. Also, the ECB exposes itself to further harm. For example, tkae the Greek PSI debt swap deal: the ECB exempted itself to avoid having to take losses on the bonds it held. If another nation is to require a debt restructuring, the ECB will continue to be exposed to losses, in which case it would have to print money to recapitalize itself. The ECB has been against the outright printing of money, so this would not make the bank executives happy.
Whatever happened and whatever is to happen will be sorted out over the next few days. The ECB reports the state of its various programs on a weekly basis, so the market will know rather shortly whether or not the ECB did act. Until then, investors may look to short the bonds after this potential intervention.
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