The absence of any ket EMU events combined with a relatively muted news flow on the debt crisis amid the summer vacations/doldrums and a major lack of bond supply from the periphery until the end of August has created a favorable environment for peripheral debt. Draghi's August 2nd comments drove risk-on and as UBS notes, this amplified the usual thin liquidity and light volumes. However, all these fun and games are about to stop as September has myriad events slated that are likely to have significant impacts on investors' demand for peripheral paper. Spain, in particular, after seeing its stock and bond markets surging euphorically, is about to suffer a double-whammy. Gross issuance for the rest of the year is estimated at EUR8bn per month (and could rise to EUR13bn per month) implying EUR4-6bn per auction twice a month - keeping bonds back under pressure as supply approaches. As if that was not enough, Delinquencies on Spanish bank loans just soared to new all-time highs, rising by the most in over three years and accelerating. So, after a calm summer vacation, Spain (optics aside) is bad and about to get much worse.
Spanish loan delinquencies bad and getting worse in a hurry...
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and supply is set to rise significantly in September and October for Spain...
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UBS: Spain’s funding outlook through year-end looks challenging
Even assuming that the Spanish Treasury sticks to its original funding plan of EUR 86bn, the Tesoro will need to continue to sell around EUR 6bn of bonds per month. Monthly net issuance should average nearly EUR 3bn. Moreover, gross issuance could potentially rise to around EUR 8bn per month and total net issuance could reach EUR 13bn if Spain adjusts for the increased net-borrowing requirement.
Considering that Spain usually carries out two auctions per month, this would imply an average issuance of around EUR 4bn per auction. The last time Spain was able to sell such an amount at a single auction session was in early March. Monthly supply has ranged between EUR 5-6bn since April (we exclude the first three months of 2012 when Spanish supply was largely supported by the two 3Y LTROs). Since that time, Spanish banks’ capacity to absorb new government paper has deteriorated.
In our view this should continue to keep Spanish bonds under pressure each time supply approaches, making Spain very vulnerable to a possible loss of market access should other adverse domestic economic factors or events cause demand to fall even further.
Spain’s situation is even more worrisome when looking at next year’s funding requirements.
In 2013, Spain will need to refinance around EUR 60bn of maturing Bonos and Obligaciones while issuing an additional EUR 45bn to cover its public deficit. In this analysis, we assume that the government’s targets for next year are reached. This amount needs to include the funding for the deficit of local administration since regional issuance is unlikely to resume next year. Similarly, the central government very likely will need to cover the EUR 15 billion of Spanish regional debt maturing in 2013, which as it stands now cannot be otherwise refinanced. Additional central government funding may also need to be provided for maturing Spanish international and agency debt such as FADE bonds for a further EUR 3-4bn.
All in all, the total amount of gross bond issuance from Spain in 2013 could be in excess of EUR 120bn. That is around 40% higher than this year, 10-20% higher than in 2009 and almost four times larger than the average amount of Spanish bond issuance recorded in the previous four years.
European event risk
Europe looms large. We expect next month to be filled with events that will shape the policy response to the debt crisis. We summarize the key points here:
On September 5, the Eurogroup will hold an informal meeting which most likely was set to discuss how to deal with a possible emergency request by Spain. The meeting is one day before scheduled issuance of Spanish government bonds. The ECB meeting on 6 September could bring more details on the new bond purchase capability announced in August, as well as heralding potential developments on the ECB’s collateral framework and liquidity provision. We perceive a clear risk that markets will be disappointed with the details, or lack thereof, forthcoming at this meeting, given the discord within the Governing Council on bond purchases. In our view, market pressure will ultimately be brought to bear before Spanish PM Rajoy requests an EFSF primary market bond buying programme.
Spain’s September 6 bond auction, after the August lull, will be a key focus for markets.
Next, on September 11 the EU Commission will unveil its proposals for a single banking supervisory authority while on the following day the German Constitutional Court is due to issue its ruling on the ESM. This will be another crucial policy event since only a favourable outcome would clear the completion of the ratification process of the ESM Treaty by Germany.
The Dutch general elections also are on September 12. Recent opinion polls suggest a rather fractured distribution of seats across the parliament, with the current five party caretaker coalition unlikely to return a majority. The Dutch Socialist Party looks likely to take the greatest number of seats, following a sharp increase in support. This party has already pledged to enact a referendum on the fiscal compact if it enters government for the first time after the elections. Other key decisions to be taken in September include the assessments by the EU and IMF on the first review by the Troika of the new Greek aid package and of the fifth and sixth reviews of the Portuguese and Irish programmes, respectively.
Also in September, Moody’s is expected to complete a review of its credit rating of Spain. If Spain is downgraded multiple notches, its bonds run the risk of being ejected from the major bond indices. The results of Spain’s bank stress tests are due to be released, too. Eurogroup and Ecofin meetings have already been scheduled for September 14-15. We expect these meetings to focus on the outcome of the ESM, EC proposals regarding bank supervision and possibly Spain bank stress tests.
Charts: UBS and Bloomberg