The Spanish Treasury's borrowing costs almost doubled at Tuesday's treasury bill auction compared with last month's sale, reflecting concerns over Spain's ailing finances and economy, but it sold more debt than it had planned to in a sign of healthy demand.
Yields on 10-year Spanish bonds topped 6% Monday, a level not seen since before the European Central Bank launched the first of its two, three-year liquidity-providing operations. However, following the auction, they held on to gains, with the 10-year yield falling 0.11 percentage point to 5.92%, with the two-year yield falling 0.09 percentage points to 3.46%.
Bund futures, trading in negative territory during the day, fell further as the results came out. They traded at 140.06, down 0.33, compared with levels of around 140.13 before the release of the results. That reflects a diminished appetite for a haven.
Spanish Prime Minister Mariano Rajoy said Monday he is aware of the loss of investor confidence in Spain's economy but defended his government's budget-cutting and reform efforts. The government warned Monday that it could seize control of finances in regional governments, which account for about one-third of public spending in Spain and make up the bulk of the 2011 budget overrun.
At Tuesday's auction, the treasury sold €3.178 billion ($4.18 billion U.S.) of 12- and 18-month Treasury bills, above the upper end of the €2-billion to €3-billion target range. The average yield on the 12-month T-bills came in at 2.623%, up from 1.418% at the previous auction March 20. The average yield on the 18-month T-bills came in at 3.110%, up from 1.711%, also on March 20.
Demand, however, was healthy as reflected by the bid-to-cover ratios, or gauge of investor appetite. The bid-to-cover ratio came in at 2.90 for the 12-month T-bills versus 2.14 in March, and it was 3.77 for the 18-month T-bills, up from with 2.93 a month ago.
However, analysts said the rise in yields bodes ill for Spain's more significant auction of two- and 10-year government bonds Thursday.
Thanks to its bold front-loading of issuance so far this year, however, the treasury can be more flexible with the offer size, and it will auction only €1.5 billion to €2.5 billion of 2014- and 2022-dated bonds. So far this year, Spain has raised almost 46% of the €86 billion it needs to borrow this year.
The ECB hasn't been buying government bonds under its Securities Markets Program for several weeks now but ECB Executive Board member Benoit Coeure reminded the market last week that the central bank could still intervene.
But Commerzbank strategist Benjamin Schroeder said the ECB council "still seems split on the issue," with some members arguing that it has already played its part in stabilizing sovereign debt markets with the latest round of three-year long-term refinancing operations.
The Spanish government finds itself facing a paradox now familiar to euro-zone members. Investors are demanding action to cut the budget deficit, but spending cuts and tax increases needed to do that will likely send the economy back into recession, and make it more difficult to cut the budget deficit.
Spain's economy, which started to contract at the end 2011, is now forecast by the government to shrink by 1.7% this year. The new downturn comes two years after the last one, marking Spain's first double-dip recession in decades. The government predicts unemployment will hit 24.3% this year, close to a 20-year high. Some analysts predict worse.
