Spanish Bonds Continue to Retreat ahead of Supply

Spanish bonds have fallen each day this week. The 13 bp increase today brings the 10-year yield increase to 30 bp this week, easily the worst performing bond market within the euro zone. Portugal has the dubious honor of being in second place with a 19 bp yield increase. Pressure is also evident in the short end of the coupon curve. The 2-year yield is up 19 bp on the day and 32 bp on the week; again easily the word performer over the past five sessions. Italian bonds 2-year yields are getting hit as well and are up 20 bp.

Spain has more supply to come next week and this coupled with European officials reluctance to take preemptive action through increasing the EFSF, or plans to issue common euro bonds, or establishing contingency funds for Spain (and Portugal) undermines sentiment. On December 14 Spain will sell 12 and 18 month bills and on December 16 Spain will sell 10 and 15 year bonds.

Italy will likely hold a vote of confidence in the government around the same Spanish auctions and the EU Summit.

Although Germany has been blamed for blocking some of the reforms suggested, a closer look reveals that the Netherlands and the Austrians also were opposed to increasing the EFSF and the common bond proposal. In some ways Eurogroup head Junker and Italian Fin Min Tremonti's proposal for collective euro bonds in an op-ed piece in the FT earlier this week was poor politics even if one agrees with the economics. A trial balloon like that without securing one's flanks, especially in this environment, produces more harm than good as it emphasizes the discord.

France seemed late to join the Germany, Austria and Netherlands. France might have been sympathetic to the proposal initially, but seeing how Junker and Tremonti hadn't lined up support, why should France stick it neck out?

While Germany has taken the lead, it is simply pursing its own national interest and naturally see Europe through that prism. In some ways, the real surprise is that France is either unable or unwilling to provide a check or offset to Germany. The press may play up the personal animosity between Merkel and Sarkozy, one aspect of the problem is, to the contrary, France has gone along with nearly every German initiative during.