This Is The Number You Need To Be Watching In Spain

We’ve been talking a lot about sovereign bond yields and Italy and Spain recently, as yields on 10-year government bonds soar cross some important benchmarks.

Despite the interest in 10-year securities, however, what we really should be looking at are shorter-term securities, which are still trading with much lower yields, both relative to 10-year debt and to their recent crisis highs.

Investors have noted that Spain and Italy have been issuing a lot of debt securities that mature in less than three years, or before banks have to repay the cheap money they borrowed from the European Central Bank in two massive three-year long term refinancing operations (LTROs).

But just how significant is this trend? We got deep into the numbers for Spain:

breakdown of spain borrowing by maturity

Photo: Simone Foxman for Business Insider/Bloomberg Data

 

The answer? Pretty significant. The graph compares the amount of debt issued by April 18 for the past three years based on denomination.

Spanish debt issuance in 2012 (green) has been heavily skewed towards 18-month borrowing in comparison to three- or 10-year borrowing, at least on a historical basis. In fact, Spain has only issued one round of 10-year debt so far this year. (That virtually matched 2010’s borrowing scheme, however note that the Spanish government borrowed a lot less all around in 2010.)

Further, Spain is issuing just about as many three-year bonds as it did last year, but also adding significant sums of shorter-term Treasury notes.

The attention paid to 10-year yields, then, seems a little overblown. Clearly, the Spanish government—and according to experts, the Italian government as well—is playing to the effects of the three-year LTROs. For example, tomorrow Spain will issue 2.5-year bonds which would mature before the conclusion of the ECB’s LTRO program, rather than the typical denomination of three-year securities which would mature after that date.

A deeper look at two-year government bonds reveals that lending at this shorter term is much less expensive than at the 10-year maturity, with yields in the secondary market at 3.4 per cent on three-year bonds rather than the 5.8 per cent on 10-year bonds.

Historically, 10-year bonds have also tended to see higher yields more frequently and for longer periods of time.

Here’s a look at two-year Spanish bond yields…

two year government bond yields spain 2

Photo: Bloomberg

…versus 10-year Spanish bond yields.

 

spain 10 year bond yields three years

Photo: Bloomberg

Italy also sees a similar wide divergence in yields: 3.8 per cent on three-year bonds versus 5.5 per cent on 10-year bonds in the secondary market.

Of course, if three-year (and shorter) yields start to surge that will be extremely problematic, whereas borrowing costs on the 10-year will remain less relevant. This would be a far surer sign that enthusiasm from the LTRO is wearing off.

Our takeaway is that 10-year government debt in the wake of two three-year LTROs is not what you want to be focusing on.

While it may be important to consider investor perceptions of how likely a Spanish default may be in the long term, right now the most pressing issue is the banking sector. With home prices continuing to fall, more and more loans likely to fail, and experts like Citi’s Willem Buiter starting to think Spain will need a bank bailout by the end of the year, short-term yields may be a better indication of investor sentiment towards Spain.

On that note…GET READY: This Is How Much It Could Cost To Bail out Spain >

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