Market Response To Schrodinger Spain

We are saved. No, we are doomed. The reaction to the much-heralded agreement to bailout Spain's banks is not good. Spanish bond yields are at their post-Euro highs at 7.21%, Spanish bond spreads (and 5Y CDS) are trading at 600bps as Valencia calls for its bailout, Montoro denies, then admits that indeed they are part of the fiasco. Spain's front-end is very weak with 3Y back over 6% with the entire curve at its flattest in 6 months. Italy is also cracking wider with the short-end getting crushed (2Y +42bps at 3.9%) - exactly where all that LTRO collateral is being held (more ECB margin calls?). While Italy's has reverted back to a zero basis to CDS, Spain has continued to see its bonds underperform CDS dramatically - which in the case of Greece and Portugal was the litmus test for a market switchijng from muddle-through to pending PSI as trust in CDS triggers reduces. Meanwhile, Germany's 2Y rate hits a record low below -6bps. Spain's IBEX is down almost 4% (but Italy's MIB worse) as EURUSD cracks below 1.22 once again. European financial credit (senior and sub) are getting cruyshed and it appears that broadly speaking equitieas are starting to catch up to the reality in credit markets - though have a long way to go. S&P 500 e-mini futures are down ove 9 pts from the close (and over 15pts from yesterday's highs). Europe's VIX is snapping 10% higher after capitulating al la US VIX but remains dramatically rich to crediot still.

Full Statement by the Eurogroup

Ministers unanimously agreed today to grant financial assistance for the recapitalisation of financial institutions in response to the Spanish authorities' request on 25 June 2012. Ministers concur with the assessment of the Commission, in liaison with the ECB, the EBA and the IMF, that providing a loan to Spain for the purpose of the recapitalisation of financial institutions is warranted to safeguard financial stability in the euro area as a whole. The Eurogroup agreed that the Fund for Orderly Bank Restructuring (F.R.O.B.), acting as agent of the Spanish government, will receive the funds and channel them to the financial institutions concerned. The Spanish government will retain the full responsibility of the financial assistance.


The financial assistance will be accompanied by policy conditionality focussing on the financial sector. This conditionality consists of bank-specific measures, including indepth bank restructuring plans in line with EU State aid rules and sector-wide structural reforms that embrace segregation of bank's problematic assets, and the governance, regulation and supervision of the banking sector. This conditionality will be enshrined in a Memorandum of Understanding that will be signed in the coming days.


The Eurogroup is confident that Spain will honour its commitments under the Excessive Deficit Procedure and with regard to structural reforms, with a view to correcting any macroeconomic imbalances as identified within the framework of the European semester. Progress in these areas will be closely and regularly reviewed in parallel with the financial sector conditionality.


The financial assistance will be provided by the EFSF until the ESM becomes available, then it will be transferred to the ESM, without gaining seniority status. It will cover financing needs of up to EUR 100 billion. As required by EFSF/ESM procedures, the specific amount will be determined based on a thorough bottom-up assessment of capital needs for individual banks, which has been launched and is expected to be finalised in September.


The loans to be used for bank recapitalisation will have an average maturity of up to 12.5 years, with any individual disbursement having a maximum maturity of up to 15 years. The EFSF will set aside EUR 30 billion at the start of the financial assistance, which can be used in case of urgent unexpected financing needs.


The Eurogroup is convinced that the reforms attached to this financial agreement will contribute to ensuring a return of all parts of the Spanish banking sector to soundness and stability.

European sovereign spreads...

which leaves Spain at Euro-era record high yields...

and European financials credit is having its hope crushed out of it - while stocks (blue) remain ever hopeful...


and Europe's VIX is 10% higher today but remains notably more sanguine than credit for now...

Chart: Bloomberg