Fisher Investments Editorial Staff
Monetary Policy, Interest Rates, Geopolitics

Bonds and Banks

By, 12/21/2011

While US lawmakers hit yet another payroll tax cut impasse Tuesday, European bankers and officials had a busy day. Here’s a brief survey of the more interesting developments.

Spanish debt auction: Sign of progress or ECB intervention?

Spain raised €5.64 billion (again exceeding the target) in its latest debt offering. Yields plunged—three-month debt’s average yield was 1.735% compared to November’s 5.11%, and six-month yields fell to 2.435% from November’s 5.227%. This marks the latest in a series of successful debt auctions for Spain, following last week’s longer maturity sales.

Given how far yields slid, many suggest external forces played a role—like the so-called “ECB carry trade.” Recall, last week the ECB announced it would provide unlimited 36-month credit to eurozone banks and lower rating requirements for collateral. This would let eurozone banks park a variety of assets (including peripheral sovereign debt) at the ECB and secure loans at 1%, earning them a nice spread between low ECB borrowing costs and higher sovereign bond yields. But this seemingly free money isn’t entirely free. Boosting banks’ leverage by increasing their exposure to European sovereign debt could dramatically worsen the impact of a sovereign default, should one occur. This risk might temper banks’ ECB borrowing, but the ECB’s credit facility does seem to be an incremental positive in terms of adding liquidity backstops and easing pressure on European banks to rapidly shrink their balance sheets by reigning in lending. Ultimately, how this plays out will take some time to determine—as with most things eurozone-related the last two years. 

In addition to ECB liquidity, fiscal measures announced Monday by new Prime Minister Mariano Rajoy likely also helped lower Spanish yields. November’s yield spike coincided with his election—at that time, folks questioned how much he could rein in Spain’s deficit. Monday’s plans provided a potential answer: A €16.5 billion austerity package, putting Spain on track for a deficit of -4.4% of GDP in 2012. Provisions include spending cuts, public sector hiring freezes, labor market reform and tax incentives to encourage small business growth. Though not an immediate remedy for Spanish competitiveness, that Rajoy seems dedicated to making tough, necessary decisions is an incremental positive.

Hungarian haranguing

Hungary has grappled with its own sovereign debt troubles for three-plus years now. It received a $28 billion loan from the EU, IMF and World Bank in late 2008, but it has yet to find its footing. Faced with sputtering economy, rising borrowing costs and a plummeting forint (Hungary’s currency), Prime Minister Viktor Orban sought a new, precautionary EU/IMF credit line last month.

Negotiations have been tense. Hungary didn’t meet the last bailout’s deficit reduction targets in 2009 and 2010. Plus, officials have long questioned Orban’s domestic “reforms,” which include stripping the media’s freedom, nationalizing private pension plan assets, limiting judiciary independence and—pending in Parliament—effectively transferring central banking powers to lawmakers. EU common law requires central bank independence, and European Commission Chief Jose Manuel Barroso announced Hungary won’t get a dime if the law takes effect.

In our view, Hungary would do well to abandon its plans. Orban says they’re aimed at preventing future central bank missteps, which he blames for the weak forint. However, we find it exceedingly difficult to imagine lawmakers setting effective monetary policy. Allowing political aims to influence interest rates, lending schemes and forint reserve usage increases the risk of unintended negative consequences.

Granted, disruptions in teensy Hungary likely wouldn’t much carry weight globally. But this is a good lesson for other peripheral states.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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