Yields on 10-year Spanish government bonds have risen by 100 basis points since the beginning of March. With attention now switching back to Spain, it seems the brief hope provided by the European Central Bank’s massive liquidity injections has proved to be a false dawn. Why has confidence evaporated so quickly?
Although Spanish bond yields are below last year’s highs, a 425 basis point premium over Germany indicates deep investor skepticism, as the display below shows.
Some may point to the European Central Bank’s (ECB’s) premature talk about exit strategies. In our view, though, the main reason is that the central bank’s actions to stabilize markets didn’t really change anything from a fundamental perspective. The injection of liquidity acted as a circuit breaker, preventing a meltdown in the banking system and indirectly supporting sovereign-debt markets by giving banks more money to buy government bonds.
But none of this addresses underlying solvency concerns. As the initial euphoria has faded, investors have once again started to focus on the uncertain outlook for many euro-area countries.
So are we simply back where we were last December? Not quite. Before the ECB’s intervention, the euro-area banking system was close to implosion. Moreover, with credit conditions tightening and business and consumer confidence falling sharply, deep recessions looked possible across the whole of the region. Fortunately, both of these outcomes now look less likely, giving debtor countries a better chance of successfully completing their fiscal and external adjustments.
Things will be tougher for Spain, an economy that is nearly twice as big as those of Greece, Ireland and Portugal combined. Sentiment has turned quickly following upward revisions to Spain’s government debt trajectory—now expected to reach 80% of GDP at the end of this year compared with an initial target of 69%—and a series of mistakes by the Spanish government. Comparisons with Greece are unfair, but skittish investors are bound to make them anyway.
Meanwhile, there is little clarity over how Spain will stabilize its debt-to-GDP ratio over the medium term; it could rise to 92% by 2017, according to recent projections by the International Monetary Fund (IMF). At some point, the Spanish government is likely to announce measures to stabilize its future debt trajectory. But this will require additional fiscal tightening. With growth already negative and unemployment high and rising, many investors will continue to conclude that this type of strategy is doomed to failure.
In our view, Spain captures the contradiction at the heart of the sovereign-debt crisis. Over the past two years, governments in (most) debtor countries have repeatedly demonstrated their willingness to implement unpopular measures in order to safeguard their membership of the single currency. In response, governments in creditor countries have committed unprecedented sums of their own taxpayers’ money to support these efforts. Unfortunately, debtor countries face a huge task and many investors fear they will not be able to complete their fiscal and external adjustments within the straightjacket of monetary union.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Darren Williams is Senior European Economist at AllianceBernstein.