Wednesday's dry toast - A communication error
In our recent blog conversations, we were already alluding to this inevitable happening and I am afraid we have arrived at this point (already intra-day yesterday). The Spanish yield curve has inverted, meaning short term yields now being above the levels of of the longer part of the curve (7y+). Under normal conditions, this could point to business cycle peaking and/or short term inflationary pressures, but with the central bank being in control in raising short term rates and securing the fact that inflationary pressures will subside in the medium term (lower longer term yields). Under extraordinary conditions, such as is the case right now, it means that markets are not even willing to hold your short term paper any more and ask for a substantial risk premium and/or are pricing in a devaluation risk in the short term. It's no longer restricted to a liquidity issue, it has become a currency/solvency issue as well. And we saw this happening in the past with Ireland,Greece and Portugal and at each occasion it didn't bode well. The Spanish 2-5 year part has suffered a lot and has moved up across the 7% frontier :
So it's decision time for all the players involved. We have currently a stale mate with Spanish authorities in denial again, thinking that for the n-th occasion they can convince the audience by saying "all goes well, nothing to worry about". On the other side of the spectrum, we have an ECB which can't/won't intervene on the markets and a bazooka not strong enough to support the whole construction. A game of chicken being played to the end but what's left for short term survival ? Should we bank on some powerful sovereign wealth funds or reserve rich countries (eg China-Japan) to come to the rescue and buy up our debt ? In their framework of thinking - currency wars - it could fit the picture quite well. Unfortunately, we do not spot a lot of enthusiastic buyers out there .
A final communication yesterday evening, quickly withdrawn from the website from the Spanish Ministry of International Affairs, sounded as follows : Spain, France and Italy urgently demand the immediate execution of the agreements stemming from the latest EU summit. No, we are not in panic mode.