Goldman Warns That Spanish Bonds, EUR Poised For Technical Breakdown

Tyler Durden's picture

As if Spain did not have enough to worry about with now daily protests gripping the main cities (the live webcam for the daily festivities in Madrid can be found here), next according to Goldman's John Noyce not only are Spanish bonds on the verge of a technical breakdown (and yields about to breakout), but due to the very high correlation between the Bund-Spain spread and the inverse EUR, it likely means that should the market start pricing in the Spanish domino, then the EUR, already lagging the move, is about to take out 1.40 rapidly. And with Spanish spreads flying as is over concerns what the Spanish elections on Sunday could mean for the country and the region, we can see something snap in advance of the weekend any minute.

From Goldman:

Spanish 10-year yields – Nearing very important triangle pivot at 5.53 and 5.58%

  • Over the last few weeks market focus on the Eurozone periphery has returned and one chart in particular which it seems important to have on radar screens in this regard is Spanish 10-year yields
  • They’ve been consolidating in a tight range since the November ’10 peak at 5.58%
  • Given the underlying structure of the multi-month chart, the consolidation over this multi-month period appears most likely to complete as a yield bullish (price bearish) continuation pattern
  • Resistance of the pattern comes in at 5.53%, a move above which would give an immediate triangle continuation target of 6.01%
  • Structurally a move significantly beyond 6% does seem quite feasible when you take into account the setup on the multi-year chart
  • Overall, this really looks like a chart which has to be on radar screens as a potential driver of EUR sentiment

Spain/Germany 10-year Spread – Breaking through material resistance

Spain/Germany 10-year Spread overlaid with inversed-“EUR Index” – Not a perfect correlation, but the broad trends are similar

  • Blue is the Spain/Germany 10-year spread
  • Green is the inverse of the “EUR Index” so higher is EUR-weakness and lower is EUR-strength. It’s approximately 30% USD, 30% GBP, 20% JPY, 10% CHF and 10% SEK.
  • From a broad trend perspective the spread and the inversed index have been positively correlated

And here is Citi's Stephen Englander adding some more color to imminent EURUSD weakness:

EUR weakens on Spanish election concern

After rallying sharply yesterday the EUR is under pressure today over concern that the Socialists will be defeated in local and regional elections. The concern is that new local and regional governments would be more inclined to reveal any corner-cutting in previous budgetary shortfalls. Spanish spreads versus Germany are now at 187bps, vs. 120bps in early April and are now at their highest level since mid-February.

Accompanying the elections has been a series of extremely large demonstrations and sit-ins that have grown in size as the election has approached. It looks likely that demonstrations will continue, even though election-related rallies are banned on the day of and prior to elections.

The anticipation by the market that resolution of peripheral debt issues will occur when the ESM takes over in 2013 means that the next two years hold a combination of rigid fiscal austerity and extremely high real and nominal rates across the peripheral countries. Sovereign borrowers may find funding in the 3-6% range form official sources, but private sector borrowers are likely to be paying rates more closely linked to secondary market rates. Thus the widening of peripheral spreads may be putting more pressure on the private sector than public sector, since private sector borrowers have to borrow at market rates. The big downside risk for the EUR is that global and euro zone economies underperform our baseline expectations and that the economic pressures end up more powerful than we expected.