June 19th, 2012
04:08 PM GMT
(CNN) - If recent history is anything to go by, the number 7 has good reason to be feared in the European bond markets.
Once yields on Greek, Irish and Portuguese 10-year notes hit that unlucky figure, they didn’t come back down - pricing three eurozone members out of the markets in quick succession and into bailout limbo.
Though it may be arbitrary, 7 could soon become the cut off point for a new two-tier common currency; an area where peripheral members pay the high price for low growth and lack of reform, whilst the more buoyant economies of the north enjoy record-low borrowing rates.
That is unless someone can convince the German Chancellor that so called jointly-issued “eurobonds” really are the panacea.
Now the eurozone’s fourth biggest economy, Spain, finds itself stuck with 7% bond yields, despite repeated reassurances from its leaders that the country is solvent, even if its banks are not.
So what’s in a number? And why is 7% so supposedly ‘unsustainable’ now?
David Nowakowski, director of fixed income research at Roubini Global Economics, says that whereas countries like Spain could have lived with yields at 7% or more in the past, the rigidity of eurozone membership doesn’t allow them the leeway to implement traditional growth boosting measures, like a full-scale currency devaluation.
Within Europe’s relatively recent monetary union, talk of cutting the value of one’s cash is something of a taboo - but that wasn’t always the case for many members.
A case in point: Spain devalued the peseta seven times between 1959 and 1993, sometimes by as much as 8% in one swoop, shrinking the value of its debts in real terms and helping to restore competition.
Nowakowski says devaluations helped European Union countries to cope with high yields in the 1990s.
“Spain was actually stronger then,” says Nowakowski. “(But today) the euro prevents such adjustments, enforcing recession and inducing crisis, rather than creating the stability envisioned by its creators.”
If growth does not pick up, Nowakowski says the current, high bond yields could make things a lot worse for Spain’s $1.4 trillion dollar economy than they are today. ‘’Sustained yields could lead to downgrades, failed auctions and a larger bailout’’ than Spain’s recent request for banking sector aid envisioned.
He lists no fewer than 11 factors that could exacerbate Spain’s crisis, including the size of its bank recapitalization needs and a possible run on their deposits.
Graham Neilson, chief strategist at Cairn Capital, thinks the euro - already close to a 2-year low - may have to weaken 25, 30 maybe even 40 percent before it will make a difference.
‘’The hope value around a big bang solution (for the eurozone) will continue to diminish over time,” he says. ‘’You can’t just kick the can down the road and push debt payments back - there have to be either losses taken, or a much more concerted effort from policymakers globally.’’
So what’s the future for Spain in the short term?
‘’I suspect the ECB will have to be the buyer of last resort for Spanish bonds,’’ says Neilson.
Which, with yields at 7%, could be an expensive option all round.
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