Bond Auctions in Italy and Spain may Reveal Success of ECB Lending Program

Joel Anderson  |

For those people who watched the markets closely this fall, today represented something of a quandary. For months the markets were wildly volatile, fluctuating up and down with every piece of news on European bond markets or a meeting between eurozone leaders. Now, Spain and Italy both have major bond auctions, auctioning off a total of $28 billion in treasury notes to high demand with falling yields...and the markets are silent.

Despite the positive news from Europe, the Dow Jones Industrial Average fells just over a tenth of a percent, the S&P essentially held even, and the Nasdaq was up just over 0.2 percent. In the end, it was bad news regarding American unemployment and lower-than-expected retail numbers held back any strong rally.

Strong Bond Auction in Italy

The news from Italy's first auction of the year were nearly universally positive. Italy sold over $15 billion in treasury bills with maturities of one year or less and saw excellent results, with the yield on 12-month bills falling to 2.735 percent, almost half the 5.952 percent the same notes sold at just one month ago. “Few would have predicted as recently as last month that Italy would be paying as little as 2.7 percent for 1-year paper,” Nicholas Spiro, managing director at Spiro Sovereign Strategy, wrote. “This is on a par with Italy’s borrowing costs before it got sucked into the eurozone crisis in July.”

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The drop in yields can be attributed, at least in part, to a lending program by the European Central Bank (ECB), which offered up unlimited three-year loans to private banks at an interest rate of just 1 percent in order to increase liquidity and spur private spending in the bond markets. The program appear to have had the desired effect, at least for now, with banks seizing the opportunity to borrow from the ECB at 1 percent then invest in Spanish and Italian debt at much better rates. The ECB's efforts also helped to press down rates on Italy's 10-year notes by buying them on the open market whenever rates reached the all important threshold of 7 percent. Rates on ten-year bonds dropped 33 basis points to 6.65 percent. With another round of low-rate three-year loans to be offered in February, the ECB is anticipating very high demand.

Spain Follows Suit

Spain's bond auctions were also a wild success, and the Treasury wound up offering a larger quantity of debt in response to increased demand. After an initial offering of $5 billion to $6.35 billion garnered over $23 billion in bids, the Spanish treasury ultimately doubled their offering to $12.7 billion. Most of that cash found its way to three-year bonds where yields fell 12 basis points to 3.384 percent. "The result is all the more impressive given that sentiment toward Spain may be cooling somewhat given the much higher fiscal deficit for 2011," said Spiro.

What? No Bump?

The absence of a leap in the American equities markets was notable, but the gains in Europe were mitigated by news that weekly jobless claims jumped to 399,000 and December retail sales remained flat when compared to November. "A lot of the euphoria around the holiday shopping season was misplaced," said Neil Dutta, an economist at Bank of America Corp. in New York. "The weakness in December implies that the handoff into the first quarter was weak. The savings rate is going higher and that's going to be a headwind for consumer spending."

However, for those readers with nostalgia for the summer and fall of 2011, one thing remained constant: solid performance on the bond markets meant European banks rose higher. The National Bank of Greece (NBG) was up just under 6 percent in early trading, the Bank of Ireland (IRE) gained just under 5 percent, Royal Bank of Scotland (RBS) announced a new round of layoffs and gained just under 4.5 percent, and ING Groep (ING) gained over 3.5 percent. On this side of the pond, Jefferies Group (JEF) was up almost 5.5 percent.

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