July 27, 2012 / 2:11 PM / 7 years ago

International investors dump Spain debt as liquidity drops

LONDON/MADRID (Reuters) - Non-resident investors cut their exposure to Spanish debt further in June, according to Bank of Spain data on Friday, spooked by concerns the country may need a full-scale bailout.

A similar pattern has affected holdings of Italian bonds this year as the euro zone debt crisis threatens to engulf the region’s third and fourth largest economies while its rescue fund does not have enough cash to support both.

Spanish trading volumes dwindled and low demand pushed sovereign average borrowing costs higher, the data showed.

The country’s banks increased the relative volume of domestic sovereign debt on their books to 30.9 percent of the total in June from 28.2 percent in May, while non-residents cut their holdings to 35.2 percent from 37 percent.

Overseas investors have been cutting their exposure to Spanish debt since the end of last year, when they held just over 50 percent and Spain’s banks 16.9 percent.

Spanish benchmark yields have risen to euro-era highs over the past week, fuelling concerns Madrid might soon lose the ability to finance itself and keeping non-Spanish investors out of the market.

Daily average trading volumes in government bonds, excluding repo transactions, fell to 13.7 billion euros ($16.9 billion) in June from 15.9 billion euros in May, Bank of Spain data showed.

Volumes have been steadily declining since mid-2011.

But market volatility coupled with buying by domestic banks flush with European Central Bank liquidity means that volumes are still well above levels recorded before the financial crisis.

“When markets were stable, we never used to do much in Spain, or any other of the periphery countries,” a trader said.

“There wasn’t much churning going on, you bought what you bought and you held on to it and that was that. Now we’re seeing all this volatility and the forced flows.”

Traders have spoken of further falls in trading volumes in recent weeks as fears have grown that Spain will need a full bailout. ECB data released on Thursday showed domestic banks stopped adding to their holding of sovereign bonds in June.

A bid/offer spread - the difference between what investors are willing to pay and what they are willing to sell for - for 10-year bonds of almost 100 cents reflects the dwindling liquidity in the market.

As Spain faces a shrinking investor base and rising bond yields, it has concentrated its fund raising at the short-end of the curve.

Over 70 percent of bonds sold this year have had a maturity of five years or less, according to Reuters data, whereas last year such paper accounted for around 50 percent.

That pushed the average maturity of the country’s debt to 6.29 years in June, down from 6.5 years at the end of 2011.

Meanwhile Spain’s cost of funding is inching higher, with the average interest rate paid 4.11 percent in June, compared with 4.07 percent in May - still below the 6.34 percent the country was paying at the end of 1998 as it adopted the euro.

Editing by John Stonestreet

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