Spain Leads Europe’s $25 Billion Gamble Before ECB

Spain Leads Europe’s $25 Billion Gamble Before ECB
Tourist souvenir postcards, including one reading "I Love Spain," sit on a rack in Valencia, Spain. Photographer: Angel Navarrete/Bloomberg

Nations are asking investors to stake at least 20 billion euros ($25 billion) on second-guessing the European Central Bank this week, selling the most debt in more than three months before Mario Draghi speaks on Thursday.

Spain, France, Austria and Belgium return to the market this week after a month-long pause, with Germany also selling debt. The auctions take place before the ECB’s Sept. 6 meeting in Frankfurt, where Draghi, the central bank’s president, may reveal details of a new bond-buying program. That makes Spanish debt at this week’s sale unattractive, according to Peter Allwright, head of absolute rates and currency at RWC Partners Ltd. in London.

“An auction this close to the ECB meeting is too risky,” said Allwright, who helps manage $4 billion. “Investing in Spanish bonds and getting it wrong is a career-ending trade.”

Spain will sell as much as 3.5 billion euros of debt repayable between 2014 and 2016 just hours before Draghi’s press conference.

Yield Volatility

The last time Spain sold bonds was Aug. 2, also before an ECB meeting. That day, the nation’s 10-year rate swung between 6.61 percent and 7.20 percent, before closing at 7.17 percent. The 1.05 billion euros of January 2022 securities it sold were priced to yield 6.647 percent.

Spanish 10-year bonds yielded 6.86 percent at 1:23 p.m. London time. The rate rose 44 basis points last week.

France, which last sold bonds on July 19, also sells debt on the day of the ECB meeting, offering as much as 8 billion euros of securities due between 2017 and 2027, while Germany sells 5 billion euros of 10-year notes a day earlier.

Belgium today sold 3.195 billion euros of debt maturing between 2019 and 2041, its first sale since July 30. The bonds due in September 2022 were sold at an average yield of 2.584 percent, down from 2.624 percent in July and the lowest for similar-maturity debt since at least the introduction of the euro in 1999.

Austria sells bonds at auction for the first time since June 12 tomorrow, offering 1.21 billion euros of bonds due in five and seven years.

“Spanish debt will be the most sensitive to the ECB meeting,” said Alessandro Giansanti, a senior rates strategist at ING Groep NV in Amsterdam. “I see a smooth auction for Germany, Austria and France.”

Target Amounts

If all the remaining sales this week meet their maximum targets, the five nations would issue a total of 20.905 billion euros of debt, the most since the week starting May 14.

Draghi said at the ECB’s Aug. 2 meeting that it’s “unacceptable” for investors to bet against the euro’s future by elevating bond yields. He said that may spur the ECB to buy short-dated bonds in the secondary market, albeit only in concert with direct purchases from governments by Europe’s rescue fund, with accompanying economic conditions. The statement followed his July 26 vow to do “whatever it takes” to defend the shared currency.

“The market will be awaiting the ECB, probably with expectations they will announce a significant program,” said Niels From, chief analyst at Nordea Bank AB in Copenhagen.

The euro area’s 17 national central bank governors will have about 24 hours to digest the ECB’s bond-buying proposal before they start debating it, three officials said last week.

The ECB Executive Board will send a list of options for the bond-buying program to the governors on Sept. 4, a day before the Governing Council convenes in Frankfurt before the Sept. 6 rate decision, the central bank officials said, speaking Aug. 31 on condition of anonymity because the plans aren’t public.

Court Ruling

Germany’s Constitutional Court is set to rule on the legality of the European Stability Mechanism, Europe’s permanent bailout fund, on Sept. 12. The central bank may delay detailing its bond-buying intentions until after that, two central bank officials said Aug. 24. They spoke on condition of anonymity because the deliberations are not public.

“We may see increased volatility running up to the meeting,” said Gianluca Ziglio, an interest-rate strategist at UBS AG in London. “The biggest hurdle is the Spanish auction because it is so close to the ECB meeting. It could be the last auction that goes well if the ECB doesn’t deliver and the ESM case goes badly. The potential for disappointment is still great.”

Investors have driven down Spanish and Italian yields in the wake of Draghi’s comments. Spanish government bonds returned 2.6 percent between the Aug. 2 meeting and Aug. 31, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Italy’s rose 3.9 percent while German bunds fell 0.5 percent, the data show.

That optimism translated into the primary market. Italy, auctioning bonds for the first time in more than four weeks, saw borrowing costs fall as it sold 7.29 billion euros of five- and 10-year bonds on Aug. 30. The Rome-based Treasury priced a new 10-year bond to yield 5.82 percent, down from 5.96 percent when a similar-maturity bond was sold on July 30.

If the ECB does unveil a substantial program, periphery yields could tumble, according to Peter Chatwell, a fixed income strategist at Credit Agricole Corporate & Investment Bank.

Italian two-year rates could almost halve to 1.5 percent from current levels, Chatwell said in interview on Bloomberg Television on Aug 29.

Conversely, if the ECB disappoints, the yields could surge, according to ING’s Giansanti. “The market is still expecting the ECB to buy bonds,” he said. “Any step back from Draghi will be taken as negative and Spanish yields will jump back to previous highs.”

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