Last week I published an article which discussed how, by delaying a formal request for aid, Mariano Rajoy risked infuriating the ECB and the eurosystem by trivializing their exhaustive efforts to come up with a plan to rescue Spain that was at least tolerable for all parties involved. Of course, the very fact that the plan was under discussion was enough to confer a considerable amount of breathing room upon Spain in the form of sharply lower borrowing costs. As noted by Goldman, rather than use the time bought by the ECB to work on a concrete plan for aid, Rajoy seems intent on testing the bond market's patience (i.e. holding out on an aid request) in order to ameliorate rising political tensions in Spain.
Apparently, Rajoy believes that Spanish citizens will see his obstinance as a sign of defiance in the face of foreign pressure rather than a simple instance of the prime minister milking the ECB-fueled periphery debt rally for all the political points it's worth. In any event, I also noted last week that the honeymoon appears to be over as periphery spreads were beginning to widen once again in the face of the growing uncertainty surrounding the Spanish bailout request. One weekend and several hundred thousand angry protesters later, and the pain in Spain has returned in full force.
On Monday, Reuters reported that the International Institute of Finance (IIF) has echoed the concerns of many a commentator, noting that the potential exists for the ECB's bond buying plan to cause massive disruptions in the market if a participating country's perceived non compliance with conditionality were to result in the impetuous termination of stability-enhancing secondary market debt purchases:
"The ECB's plan to buy sovereign bonds may result in a "cliff effect" if a country fails to meet conditions tied to the purchases. Termination of bond purchases could lead to an "abrupt" market correction."
Furthermore, the IIF noted that the conditionality attached to enrollment in the OMT program may cause undue delays in its implementation.
Meanwhile, the Bank of Spain reported that due to a sharp decrease in household and corporate deposits in July, Spanish banks' loan to deposit ratio rose to 187%, which is a problem considering that, as noted by Bloomberg,
"...the terms of Portugal's May 2011 bailout require its banks to achieve a loan-to-deposit ratio of 120 percent by the end of 2014, while Ireland's deal demands a ratio of 122.5 percent by 2013."
This raises the specter of a similar requirement for Spain as part of any new bailout deal. Any such requirement would likely cause lending to decline sharply as banks attempt to meet the new ratio requirement.
Perhaps the most worrisome set of figures are those regarding Spain's consolidated cash balance and the redemptions it faces in October. Put simply: it isn't clear if they will have enough money. In July Spain's national account monthly cash balance fell to around 20 billion euros. It faces 15 billion euros in redemptions in October.
The result of this growing pessimism: yields on Spanish debt have begun to climb steeply once again. Yields on Spanish 2s and 10s each rose 20 basis points Monday with the 10-year back above 6% for the first time since the new bond buying plan was announced. Investors should short Spanish bonds and Spanish equities (EWP) on growing skepticism about the effectiveness of the ECB's plan.