Spanish 2-Year Notes Advance a Fourth Day on Bailout Speculation
Comment of the Day

August 17 2012

Commentary by Eoin Treacy

Spanish 2-Year Notes Advance a Fourth Day on Bailout Speculation

This article by Lucy Meakin and Keith Jenkins for Bloomberg may be of interest to subscribers. Here is a section:
Spain's two-year notes advanced for a fourth day on speculation the nation will request a sovereign bailout that would trigger European Central Bank purchases of its government debt.

Spanish 10-year bonds outperformed all their euro-region peers, pushing yields to a six-week low. German 10-year bonds extended the biggest weekly decline this month after Chancellor Angela Merkel signaled support for the ECB's plan to insist on conditions in exchange for helping reduce indebted countries' borrowing costs. Spain's two-year yield may drop to 2 percent with ECB purchases, said Steven Major, HSBC Holdings Plc's head of fixed-income research.

ECB buying “would reinforce the rally in Spanish bonds,” said Nick Stamenkovic, a fixed-income strategist at broker RIA Capital Markets in Edinburgh. “Given the fragile position of the Spanish economy, it looks almost inevitable Spain will require a bailout.” Shorter-term securities are the “most attractive” maturities, he said.

Spain's two-year note yield slid 24 basis points, or 0.24 percentage point, to 3.75 percent at 10:57 a.m. London time, after reaching 3.72 percent, the lowest level since Aug. 7. The yield has fallen 45 basis points this week. The 4.75 percent security due in July 2014 rose 0.435, or 4.35 euros per 1,000-euro ($1,237) face amount, to 101.834.

Eoin Treacy's view As Eurozone politicians headed off on their summer holidays from mid July, the chatter among investors was focused on the likelihood of another panicky sell-off as seen in August 2011. Perhaps the most overt evidence of ECB activity to avoid such an outcome is observable in the continued compression of the Eurozone's equivalent of the TED spread (3-month Euro LIBOR – 3-month generic government rates). The 350 basis point fall in short-dated Spanish government bond yields has also signalled an acceptance that the most bearish expectations are unlikely to unfold.

Spanish 2-year yields halved between the last week of July and August 6 th before staging a partial relief rally. Demand returned in the region of 4.33% from earlier this week and a sustained move above at level would be required to question potential for additional compression.

A great deal of anxiety has been expressed regarding Spain. However, what has become apparent is that political will is beginning to coalesce around the notion that more cooperation is the only viable option for the currency union. The stock market, which has been under considerable pressure over the last year, has rebounded impressively since early July. It hit a new three-month high yesterday and has closed the overextension relative to the 200-day MA. While mildly overbought in the very short-term, there is significant additional scope for a further unwind of short positions. A clear downward dynamic would be required to check momentum at this stage.

Grifols and Inditex have outperformed both the Spanish and European markets by a considerably margin this year. However, despite their rock star status, volatility has increased and they are both susceptible to mean reversion.

What is perhaps most notable about the recent rally in Spanish equities is the outperformance by a number of banking shares. Banco Santander and BBVA have pushed successfully back above their respective 200-day MAs while Bolsas y Mercados Espanoles has also rebounded strongly. (Also see Comment of the Day on May 14th when these shares were losing downside momentum). In the insurance sector, Corporacion Mapfre has rebounded particularly impressively.

Solar industry shares have all bounced over the last couple of months and Abengoa has benefitted from short-covering. The share lost momentum in the region of the 2008 lows and rallied this week to break the almost two-year progression of lower rally highs and closed the overextension relative to the 200-day MA. A sustained move to new lows would be required to question potential for a further recovery. (Also see Comment of the Day on June 21st).

In the utilities sector, electricity provider Endesa failed to sustain the break to new lows in July and has since rallied to break the progression of lower rally highs. A clear downward dynamic would be required to check momentum beyond a brief pause. Transmission provider Red Electrica de Espana (6.4%) has been largely rangebound but is rallying strongly from the lower boundary.

In the oil & gas sector Repsol (6.86%) failed to sustain the downward break in July and has rebounded emphatically over the last few weeks to close the overextension relative to the 200-day MA. A sustained move to new lows would be required to question medium-term recovery potential. (Also see Comment of the Day on August 2nd ). Enagas (6.62%) has been largely rangebound since 2008 and is currently rallying from the lower boundary.

Telefonica found support in the region of €8 from late July and has now returned to test the upper side of the overhead range. A clear downward dynamic would be required for this area to present anything other than temporary resistance. (Also see Comment of the Day on July 2nd).

In conclusion the Spanish markets have been subject to some of the most extreme bearish sentiment anywhere. However, as the likelihood of a less disastrous outcome prevails shorts are covering and fuelling a substantial relief rally. A return to medium-term demand dominance will be confirmed once support is found at progressively higher levels following pullbacks and moves are sustained above the 200-day MA.

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