Last Thursday and Friday, European leaders held a summit for the umpteenth time in order to talk about ways to avoid a collapse of the euro, among other topics. And by the first day of this week the outcome was more than positive. Stock market investors continued their buying streak from last week, and investors also pursued bonds from the peripheral countries in light of the feeling that this time around, politicians in Europe would reach some form of agreement and adopt solutions that could bring the two-year European debt crisis to an end.
Such a buying frenzy caused the Spanish risk premium to drop 300 basis points, closing the trading session at 291 basis points. The level has not been this low since October 12. The premium exits the danger zone still inhabited by the Italians, whose risk premium fell beneath 400 to 375. The reform measures announced on Sunday by Italian prime minister and technocrat Mario Monti will consider raising the VAT tax by 21%, average employment age and pensions, among other items.
The reforms should give much-needed confidence to the Italian debt markets. Unlike other occasions when the Italian risk premium fell mainly due to a rebound in the German debt market, yesterday?s retreat had a lot to do with the buying up of peripheral debt.
Yields on Italian bonds fell from 5.95%, which marks the strongest fall since August and the first time that it has been under 6% since October 26 when a European summit agreed to recapitalize the banking sector, forgive 50% of Greek debt, and leverage a billion euro European Recovery Fund.
Buying improved on the Spanish debt market as well. Ten year notes rose to 5.12% from 5.68% on Friday, polishing off six straight sessions of declines and a streak since the ECB resumed its program to buy debt from ailing peripheral nations, which now exceeds 200 billion euros. In this way, the yield on these bonds has already fallen 23% since they hit an historic high of 6.69%.
This happened despite the possibility that the ECB will proceed as the Fed did and dedicate itself to buying massive amounts of debt seems less likely today than yesterday given Nicolas Sarkozy will align with Angela Merkel to defend the independence of Mario Draghi?s organization. ?It is not necessary that the ECB make a major effort to bridge the differences.
The spread between Italian and Spanish bonds compared to those in Germany was so unjustified that the simple fact that the purchase plan was announced made investors continue to get drastically improved risk premiums,? affirms Miguel Paz from Unicorp.
Still, he warns, ?We already know that our political class only acts emphatically when it is in the water up to its neck. If they look at the macroeconomic numbers, the water is already up to their chins, but if the risk premium and stock markets continue to improve as they did last week, then we could regain some confidence.?
