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Spain debt market gives Europe unsettling sense of deja vu
LONDON (Reuters) - Spain's short-term borrowing costs are on course to overtake its longer-term ones in an unsettling deja vu for the euro zone suggesting its fourth-largest economy could soon be squeezed out of commercial markets.
Ten-year Spanish yields hit their highest since the euro was created this week after a number of regional governments were reported to be considering help from Madrid.
Borrowing costs have climbed well above the 7 percent mark considered unsustainable and beyond which other euro zone members have requested bailouts.
Analysts are particularly worried about the rise in yields on short-term debt near or above the 7 percent line. They fear rates are becoming prohibitively high on the very maturities the Treasury has relied on for much of its 2012 funding.
"You are getting to that tipping point where it seems there is just a complete lack of confidence in Spain's ability to fund itself and the market has basically given up on it," Gary Jenkins, director of Swordfish Research said.
"The market is just saying Spain is a done deal, they are going to need a proper full bailout."
That waning confidence was reflected in the rise of 10-year yields to 7.6 percent and a jump in the cost of insuring Spanish debt against default to a record-high this week.
Yields on 10-year debt issued by Greece, Portugal and Ireland quickly spiked after breaking above 7 percent, before they each in turn received help from international lenders.
Short-dated Spanish government bonds have suffered the most, narrowing the difference in yields between 10- and 2-year bonds to its tightest since December. Five-year yields rose above 10-year ones, and the latter have surpassed their 30-year equivalent, nearly fully inverting the yield curve.
Short-term yields rising above longer-term yields is usually a sign that markets are pricing in a greater risk of a credit event. The move was similar to the flattening and eventual inversion of yield curves in Greece and Portugal before they received international help.
"You can easily tell from this kind of dynamics, even before the curve inverts, that it's probably nearing the game over point for Spain," Gianluca Ziglio, strategist at UBS said.
LEAGUE OF ITS OWN
To be sure, the size of Spain's economy makes a comparison with smaller aid-receiving euro zone members tricky.
Like Italy, Spain's borrowing costs have partly been capped by demand from domestic banks who benefited this year from 1 trillion euros ($1.2 trillion) worth of cheap European Central Bank financing.
Some analysts had argued that Spain's sizeable debt market meant it would take longer for secondary market yields to filter through to its overall financing costs compared with others.
Government efforts to keep market pressures at bay by pushing through unprecedented austerity measures have partially backfired. Markets now blame the weak growth outlook and high unemployment for undermining investor confidence.
Indeed, the latest bout of volatility came after the government cut its economic growth forecasts for 2012 and 2013 and after Valencia, one of Spain's most indebted regions, said last week it would apply to Madrid for financial help.
UBS's Ziglio estimates the regional debt burden, along with the government's upward revisions to its 2012 public deficit target, may cost the government an extra 20 billion euros this year at a time when borrowing costs are becoming prohibitive, especially at the short end.
Two-year debt yielded 6.8 percent and three- and five-year bonds yielded well above 7 percent.
"They have been increasingly putting in their issuance to shorter-dated maturities. There is only so long that can go on for, and now the very front end is getting to levels that are starting to be relatively penal rates," Eric Wand, strategist at Lloyds Bank said.
While Spain has already completed a good part of this year's funding, the remaining issuance may be more of a struggle given current yield levels.
Spain has raised 66 percent - or 57 billion euros - of its 86 billion euro 2012 funding target, after front-loading issuance earlier this year to benefit from banks being flush with ECB cash.
Nearly 45 percent of the 2012 funding was done by mid-March. Since then, issuance has slowed as the effects of the ECB operations waned and as the Treasury opted for lower auction volumes to ensure their success in a volatile environment.
There are also signs that the domestic banks are less willing to absorb the supply, analysts said.
"If you look at the technicalities of the auction, the way they are done (recently), the lowest accepted price is very low compared to the market price at the time of bidding," Ziglio said. "It definitely shows that there is no willingness to take down the supply unless there is a massive concession in terms of additional yield."
Without sustained demand from domestic banks, Spain's market access days would be numbered. A sovereign bailout would drain regional funds to deal with a crisis just as the focus turns to Italy - whose economy is deemed too big to be bailed out.
"The danger is if Spain requires a bailout, the market will say 'Italy is next'. And if that happens you have a major problem," Jenkins said.
Europe would then face a tough choice, he said: "Are we going to go for a fiscal union, joint several liability for the debts, or are we going to break up?"
(Additional reporting by David Cutler; Graphics by Vincent Flasseur; Editing by Hugh Lawson)
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