The Spain Curve Inversion In All Its Gravitational Glory

UPDATE: *ITALIAN TWO-YR NOTE YIELD RISES ABOVE 5%, 1ST TIME SINCE JAN 11

While every wannabe bond-trader and macro-strategist can quote 10Y Spanish yields, and maybe even knows what the front-end of the Spanish yield curve is doing (and why), there are three very significant events occurring in the Spanish sovereign credit market. First is the inversion of the 5s10s curve (5Y yields were above 10Y yields at the open today); second is the velocity with which 2s10s and 5s10s have plunged suggesting a total collapse in confidence of short-term sustainability; and perhaps most critically, third is the record wide spread between the bond's spread and the CDS (the so-called 'basis') which suggests market participants have regime-shifted Spain into imminent PSI territory (a la Greece and Portugal) as opposed to 'still rescuable' a la Italy for now. As we pointed out earlier, there is little that can be done (or is willing to be done) in the short-term, and the inevitability of a full-scale TROIKA program request is increasingly priced into credit markets (though its implicatios are not in equities of course).

 

Spanish 5s10s Inverted earlier - is stable now at single-digits...

 

but 5s10s have plunged dramatically in the last few days...

 

as has the more critical 2s10s...

 

but it is the CDS-Cash basis for Spain has dropped to record lows (this means bonds trade at their cheapest - widest spread - relative to the supposedly fungible CDS market ever)...

 

This is key. The point is that basis traders (who buy the 'cheap' bond against buying CDS protection) are happy to scalp for 50-100bps here and there on liquidity dislocations BUT once the sovereign becomes 'likely' to enter some kind of PSI - during which we already know the powers-that-be will do all they can to avoid triggering CDS for some mysterious reason - then there is too much event risk for arbitrageurs to save the bond. Just as we have said before - the only natural buyer of these Spanish bonds was the arbitrageurs and now they are lost, it is little wonder that with the Spanish banks unable to find any cash to fnd their own buying, Spain looks a lot like its kissing-cousin Portugal...

Portugal's CDS-Cash basis flipped regimes and has stuck there since the bailout requests began...

 

 

So in summary: Spain has lost the confidence of even short-dated traders; it would appear that even the 'Sarkozy' carry trade is not acceptable anymore as inversions occur; and now Spain has lost the arbitrageurs - signaling expectations that a fill TROIKA program is inevitable with its asscoated 'stigma' and PSI.