Euro zone bailout fund could guarantee partial losses on Spanish bonds

Euro rescue fund

The Madrid stock market celebrated Wednesday that ratings firm Moody’s had announced it was keeping Spanish sovereign bonds within investing grades, Baa3, even though under negative outlook. Equity markets in Europe were up with the Spanish Ibex heading to a 105-point rise. The euro appreciated to over $1.3, and yields on 10-year Italian and Spanish bonds fell moderately.

All three risk agencies–Moody’s, S&P and Fitch–have now placed Spain’s debt at a one-notch distance from so-called junk status. But it was the recent decision by Moody’s that led investors to buy in what had during the last weeks been just rumours.

Analysts’ reports in Spain basked in unconfirmed intelligence. One option, according to Banco Santander experts, would be that the European Stability Mechanism (ESM) may guarantee between 20 percent to 30 percent of first losses on sovereign debt, “propping up Spanish bonds on the primary market besides the already established unlimited purchases [by the European Central Bank] of short-term paper” on secondary markets.

Link Securities said president Mariano Rajoy’s government could request a cautionary rescue line with the only aim of bringing the European Central Bank into action. “If external credit costs relaxed sufficiently, Spain’s use of this finance programme would be minimal,” analysts suggested, “and the volume of funds from the ESM would remain sound enough to offer support to other countries, if need be.”

“Moody’s previous assessment about the risk of the Spanish sovereign losing market access has been materially reduced by the willingness of the central bank to undertake outright purchases of Spanish government bonds and to contain their price volatility,” the rating agency indicated in its credit research note release.

It also believes that “Spain will likely apply for a precautionary credit line from the ESM.” This should in turn help sustain demand for Spanish government bonds by “allowing the European Central Bank to activate its Outright Monetary Transactions programme of secondary market purchases.”

Moody’s confirmed that entry into an ESM capital line would not in itself lead to a downgrade.

Germany’s and Spain’s efforts to spread the impression that a bailout isn’t urgent was supported by the “strong demand” for Spanish one-year and 18-month bonds in the last auction, analysts at Link remarked after the Moody’s grade verdict. The Spanish Treasury sold on October 16 €4.864 billion over a €4.5 billion target, at a lower marginal cost in both maturities.

The Spanish government would need to increase its average debt sales to €4.5 billion per auction, most financial reports outlined, to reach the €200 billion gross issuance target for 2012.

About the Author

Victor Jimenez
London contributor at, reporting about the City and the Eurozone economies. He regularly writes for Spanish newspaper group Prensa Ibérica--some of his features include shared work with journalists of The Daily Telegraph and the BBC.

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