Eurozone debt refinancing set to test policy reform

6th January 2012

Italy was the first major Eurozone country to issue debt after the latest round of negotiations. An auction of short-dated debt in late December suggested that the market perception of Italian debt might be shifting. This was the FT's verdict: "The successful auction of €9bn of six-month bills – sold at an average yield of 3.25 per cent, down from a euro-era record of 6.5 per cent last month – brought some relief early on Wednesday to Italy's bond market, the world's third largest."

But the next day saw a more disappointing auction of longer-dated debt, suggesting that the market still believes that the country's problems have been postponed rather than solved. This was the Guardian's take on it:  "The euro sank to a 15-month low against the dollar on Thursday as the European Central Bank (ECB) reportedly stepped in to prop up Italian bonds following an auction that revived fears Italy may be unable to refinance its huge €1.9 trillion (£1.5tn) borrowings.

"It saw the yields on bonds with maturities ranging from three- to 10-years all fall below last month's record highs. But the average return demanded for the 10-year bonds, at 6.979%, was still within a whisker of the 7% level that has triggered bailouts elsewhere in the eurozone. And overall the offer was undersubscribed.

The weakness of this auction left all eyes on the French auction. Although yields rose, the French Government was generally considered to have bought itself some time: "France sold €4.02bn of 10-year debt at average yields of 3.29pc, up from 3.18pc at a similar auction last month. Demand outstripped supply by a ratio of 1.64 to one, compared with 3.046 to one at a similar auction in December. The country also sold bonds maturing in 2023, 2035 and 2041 at similar rates as they achieved in December. Demand was stronger at these auctions, with the country raising a total of €7.96bn of its €8bn target.

"France currently has the highest long-term borrowing costs of the six eurozone AAA-rated countries. Yields on benchmark 10-year bonds stood at 3.298pc on Thursday morning, compared with 3.219pc for Austria, 2.268pc for the Netherlands, and 1.896pc for Germany."

As it was, the French auction appeared to restore some equilibrium to markets and the German and Portuguese auctions yesterday passed off relatively uneventfully : "Germany was able to sell more than €4bn of 10-year government bonds for the first time in three months. Demand for the bond sale was notably better than at the bond's November launch, which was one of Germany's least successful debt sales since the introduction of the single currency." The piece quotes Achilleas Georgolopoulos, a strategist at Lloyds Bank in London saying that the market should see the auction as a ‘decent start for the year'.

But there is no plain-sailing in the Eurozone and most analysts and economists agree that the real test of faith in Eurozone policymakers will be the Spanish and Italian auctions next week. As this CNN article points out, the Euro has seen substantial selling pressure as investors remain unconvinced of the ability of Eurozone governments to roll over their debt in the longer-term : "The euro's reaction to the French auction was a repeat of selling seen the previous day, when investors dumped the currency despite reasonable demand at an auction of German bunds. Analysts said this was a sign of strong negative sentiment towards the single currency."

There have been some notable beneficiaries from the relative weakness in the Eurozone, however. The most recent gilt auction saw strong demand from a broader investor base and low yields as investors continued to view the UK as a safe haven: "International investors are buying record amounts of UK government bonds as demand is spurred by the Bank of England's emergency quantitative easing programme as well as Britain's status as a haven from turmoil in the eurozone. The government's long-term benchmark borrowing costs have fallen to lows last seen in the 1890s, helped by demand from some of the world's biggest sovereign wealth funds."

The early signs from the Eurozone debt refinancing reveal little new. Markets are still nervous, but marginally less nervous than they were at the height of the crisis in late November, early October. There is certainly nothing to suggest that the Eurozone crisis is nearing a conclusion.

 

More on Mindful Money

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How Eurozone uncertainty effects UK employment

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