Last week, Spain's Treasury raised $5.82 billion euros at auction in the country's first debt sale of the year; this was well above even the upper end of the target range. The auction, which the Wall Street Journal described as 'robust,' was enough to drive yields on Spanish 10-year notes below 5% for the first time in 10 months.
The Treasury in Madrid sold three bonds, one maturing in 2015, one maturing in 2018, and a 2026 note. Yields were down across the maturities compared with the last time the notes were sold and, in the case of the 2026 note, compared with where it traded in the secondary market. The consensus, which of course is somewhat justifiable, is that the successful auction indicates demand for Spanish debt isn't going to dry up anytime in the very near future. Here's Annalisa Piazza, a fixed income strategist quoted by the Wall Street Journal:
Today's Spanish auction suggests that market appetite for euro-zone periphery's debt remains solid despite uncertainties regarding the request for a bailout and eventual activation of the European Central Bank's Outright Monetary Transactions.
The problem for Spain in 2013, however, is that two major sources of demand for the country's debt are likely to be largely unavailable in the coming year. In a rather disconcerting piece published on January 3, the Wall Street Journal disclosed that Spain has now spent over 90% of its Social Security Reserve Fund buying its own debt. Just to reiterate: Spain has spent pretty much the entirety of its pension fund on its own bonds.
There are three obvious problems here. First, this means that the fate of pensions in Spain is now hopelessly intertwined with the fate of Spanish government bonds, a fact that doesn't inspire much confidence, given the market for periphery sovereign debt in 2012. Indeed, the Wall Street Journal notes that the decision to invest the Social Security Reserve Fund's cash in Spanish government bonds violates a Spanish government decree which states that the fund can only purchase securities "of high credit quality and a significant degree of liquidity." This is terribly ironic given that if anyone should know that Spanish government bonds are not of the highest quality and are certainly not highly liquid, it's the Spanish government.
The second issue involves the contention made by the Spanish government that the practice of betting the pension fund on Spanish government bonds is sustainable as long as Spain retains market access. It is inconceivable that anyone in a position of authority could miss the obvious contradiction here. Were it not for the purchases made from the Social Security Reserve Fund, Spain might have lost market access last year. So to say that this practice is sustainable as long as Spain retains market access is basically a tautology. That is, if Spain depends on the pension fund for market access, then the pension fund cannot depend on that same market access - that is circular reasoning at its worst.
Third, if 90% of the Social Security Reserve Fund has already been invested in Spanish government bonds, there can't be much left to invest. It is conceivable then, that demand for Spanish bonds will suffer in 2013 given that the pension fund's hands are now tied. This problem could be complicated by the fact that Spain's banks already own some two-thirds of all Spanish government debt outstanding, meaning they aren't likely to step up to the plate either. In other words, foreign demand needs to rebound, a speculative proposition at best.
Anyone who is optimistic about the prospects for Spanish debt and, by extension, about the prospects for a prolonged dissipation in the European debt crisis, should note also that the 2-year note which was auctioned last week by the Spanish Treasury included a Collective Action Clause, or, CAC. This effectively means that in the event of a deterioration in the market, individual creditors would not have the right to hold out should the majority of bondholders vote to reschedule the debt. As "Out Of The Box" author and Wall Street veteran Mark Grant recently noted,
The clear signal here is that Spain is in serious trouble or CAC's would not be an issue and that the State will put it to bondholders if necessary. (emphasis mine)
In short, investors shouldn't be tempted by the relentless quest for yield to test the waters with Spanish government bonds. All is not well in the European periphery, 'Draghi put' or no.