Spanish Bonds Show the Perils of Getting Ahead of the ECB

The central bank is a solid supporter -- in more ways than one.

The Spanish bond market is stronger than Catalonia's independence crisis. In fact, it's practically pricing in a speedy return to normal. 

It's not just that the politics are moving Madrid's way. A poll in the El Mundo newspaper shows support for the province's independence has fallen to just a third. If this were mirrored in outcome of regional elections called by the Madrid government for Dec. 21, then pro-independence parties would lose their majority in the Catalonian parliament.

The fixed-income savior is the European Central Bank. It has Spain's back -- in more ways than one.

Spanish 10-year yields are down about 7 basis points since Friday, and 30 basis points since the Oct. 1 referendum. Part of the story here, as Gadfly has noted, is that the nation's maturing debt tends to get reinvested. In this case, some 16.8 billion euros ($19.5 billion) comes due on Tuesday, along with 7.1 billion euros in coupons. 

Part of the reason Spanish debt avoided a panic sell-off was because investors were aware that the ECB had the flexibility to step up its buying, if required. Though its purchases are supposed to be limited by the capital key, a formula that determines how much of each nation's debt the central bank can buy, it nevertheless has scope to overbuy a specific country's debt. Officials most notably exercised this option earlier this year for France and Italy. 

The ECB's decision last week to extend quantitative easing means its support for the region's government bond markets is not going away anytime soon. That helps contain the risk that political crises morph into serious economic problems.

Now the ECB has an even bigger carrot.

The big driver of lower yields after Thursday's ECB decision was the plan to re-invest maturing holdings. The details on how officials will approach this will be released next week, but they'll likely show the benefit for peripheral markets will be even more pronounced than for the core. 

That is because, in addition to the trillions of euros of holdings from the current Public Sector Purchase Program, the ECB also has 89 billion euros of peripheral debt acquired through the PSPP's predecessor, the Securities Markets Program. The SMP operated from May 2010 to Sept. 2012, and purchased bonds from countries struggling to shore up their finances -- including Spain. Much of that debt should be on its way to maturing. This adds weight to the ECB's re-investment plan, as these SMP holdings should also be re-cycled into new buying. 

The old adage of don't fight the central banks is alive and well in Europe.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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