Spain bond-buying hopes grow but questions remain

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By:
Euromoney Skew, Sid Verma
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When will the Spanish government formally request official assistance from the European Financial Stability Facility (EFSF)? And in what form would the ECB’s assistance take?

After a few quiet weeks in euroland, hopes are growing the ECB is paving the way for an aggressive bond-buying plan, following media reports over the weekend.

Germany’s Der Spiegel reported that one of the options being discussing by eurosystem committees was to set a target bond spread for southern Europe. Meanwhile, in an interview with Spain’s EFE, the country’s finance minister Luis de Guindos said Spain would prefer the ECB to commit to unlimited intervention in secondary sovereign debt markets before it formally requested official fiscal assistance.

Adding to bullish speculation that further monetary accommodation would precede a formal bailout request, ECB executive board member Jörg Asmussen – who is seen as close to Germany – in an interview with Frankfurter Rundschau, argued that the new bond purchase programme would be "better conceived" than the original Securities Markets Programme, driven by the need to reduce perceived convertibility risk and repair the monetary transmission.

Finally, Spain’s El País reported that Spain was looking at tweaking its budget and tax policies this fiscal year to meet more-stringent budgetary targets, seen as a pre-cursor to a formal financing request to the EFSF/European Stability Mechanism (ESM).
 
Barclays analysts are bullish: 

Overall, when taken together, such reports suggest that we are moving towards triggering a forceful purchase programme by the combined forces of ECB and EU funds next month, though the formal decision on this might well not be taken by the eurogroup until its September 14 meeting (which comes just after a G20 finance minister and central bank governor meeting. However, it seems likely that private discussions will be taking place at the eurogroup level and with the ECB ahead of the ECB's meeting on September 6).

However, these disjointed reports, mostly backed by unnamed sources, persistently raise the question: when will the Spanish government formally request official assistance from the EFSF  – which ECB governor Mario Draghi has said must come before any bond-buying programme, despite media reports this weekend to the contrary – and in what form would the ECB’s assistance take?

Analysts at CreditSights are bearish on the former question: 

The ECB will still insist that a formal request is made to the EFSF before any purchases are made and will insist that those governments adhere to any macro-economic adjustment programme that is agreed as part of that request. Given that cutting spending and raising taxes when private-sector demand is already weak is practically certain to further undermine total economy spending and undermine employment and incomes, such adjustments will prove politically contentious. And as long as there is a risk that the reforms and cuts will prove politically unpalatable and undeliverable, then there is a risk that the ECB will end its policy.

Still, most reckon the ECB will make good on its promise. And there is the EFSF. Promisingly, any request to the EFSF could almost immediately trigger EFSF bond-buying of Spanish debt, CreditSights (CS) argues:

... government request for EFSF bond purchases in the secondary market should take two to three days to be approved and implement. However, in the case of Spain, it may take less time because the government has already signed a master agreement with the EFSF. Although the €100 million is intended for bank recapitalization, it seems that it also could be used to buy bonds in the secondary (or primary) market.

Any move to purchase Spanish debt in the primary or secondary market would require 85% majority support from eurozone heads of state. CS reckon intervention in the secondary market by the EFSF is more likely for now, since primary-market purchases would need to be conducted under a precautionary credit line or a macro-economic adjustment programme, as per the EFSF guidelines

The problem with a precautionary programme is that, according to the guidelines, it requires that “economic and financial situation are still fundamentally sound”. Eurozone leaders might argue that the economic situation in Spain is fundamentally sound, although we would disagree, but “the members of the eurogroup decide by unanimity on a proposal from the EFSF whether to grant such a credit line”. That might see a northern European government dissenting and slowing up the approval process.

What’s more, CreditSights argues:

If Spain is to seek assistance via primary market purchases, it seems more likely that they will wait and see how their bonds are trading in the secondary market as they get closer to that October refinancing requirement. If bond yields deteriorate in the meantime and they decide they require assistance earlier than that, then a secondary market purchase programme is more likely. Of course, with no major non-bill refinancing requirement, the Spanish government may prefer the ‘threat of purchases’ in the meantime to stabilize the market and wait until October before actively doing anything to support its funding position.

In summary, it’s unclear what will come first: EFSF or ECB bond-buying. Any Spanish funding request made to the EFSF would also presumably activate ECB bond-buying, which would help to cap yields in the secondary market. Granted, the jury is out on whether this will prove short-lived given the macro-economic and market dysfunction, and markets could well see it as an opportunity to sell.

Analysts at CreditSights reckon primary-market intervention in Spain won’t be forthcoming for now, given the bailout gymnastics needed and Spain’s quiet debt issuance calendar.

However, there is an upside: as we have reported, the EFSF, or ESM, if and when the German court rules in favour of the fund’s legality in September, is in no position to undertake bond purchases in large volumes. Any ECB action then, after Spain’s request to the EFSF, might succeed in buying eurozone policymakers more time for game-changing action: debt mutualization.