Spain: Still A Headache For The Euro

by: Kathy Lien

Spain is back in the headlines and causing trouble once again for the euro. Spanish 10 year bond yields settled at 6.93 percent, just a hair shy of the 7% danger zone. While Spain is gearing up to sign a memorandum of understanding for their bank bailout with Eurozone Finance Ministers on Friday, investors are nervous about the country's ability to reduce its deficit and control its finances with yields on the rise. Spain had a terribly difficult time attracting investors for their latest bond auction, which reflects the market's general concern that the bank bailout won't mean the end of Spain's troubles. The euro received a boost after the German Parliament finally approved the rescue package for Spanish banks. The bailout would not have been able to proceed without the monetary support from Germany. As the leader of the opposition party said, they supported the measure only "because a refusal by Germany would be catastrophic." However the Germans made it clear that they refuse to let the money go directly to Spanish banks, bypassing the sovereign until the European Central Bank takes control of banking regulation in the region.

Eurozone Finance Ministers will be holding a videoconference on Friday to discuss the final terms of the bank bailout for Spain and sign a memorandum of understanding. A draft has already been released but it is unclear which terms will stay and which will go. We will be looking for any details on debt subordination, the EFSF's role, the use of funds and the allocation to banks. If senior bondholders are subject to losses, it should not be good for the euro. It is important to continue to keep an eye on Spanish bond yields. At 7% or greater, servicing debt becomes prohibitively expensive for Spain. When yields broke above this critical mark in June, it pulled back quickly but if 10 year Spanish bond yields rise above 7% again and stay there for an extended period of time, the risk of a sovereign bailout increases significantly. Spanish-German bund 10-year bond spread hit a record high, which tells us that investors are looking at the euro through two different lenses - euronorth and eurosouth. The North is safe to invest in, the south is not. German producer prices are scheduled for release on Friday.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.