The relief rally in Spanish bonds occasioned by what I have described as 'backwards logic' on the part of Moody's faded Monday with yields on Spanish 10s rising 12 basis points even as Mariano Rajoy's Popular Party won a regional election in Galicia paving the way for the institution of more austerity measures. As Reuters explained, the election results have been largely overshadowed by the realization that Germany will block ESM funding of bad 'legacy assets' in Spain's faltering financial sector.
Investors should note that contrary to popular belief, the eurozone debt crisis is far from resolved. The temporary relief occasioned by the ECB's OMT plan rests on fundamentally flawed logic: the fact that the central bank may have to step into the secondary market in order to keep Spain and Italy from losing market access is a bad thing, not a positive development. When Spain can borrow at sustainable rates without the ECB's implicit or explicit backing, commentators will have cause to claim that the crisis has abated but not until then.
Meanwhile, Germany continues to make it abundantly clear that it views the policies undertaken by the ECB to be foolish. In its latest monthly report, the Bundesbank heaped criticism on the ECB's plan, noting that
"The common monetary policy mitigates and delays the adjustment process through single short-term interest rates and liquidity support measures."
This echoes the sentiments of Joachim Scheide, head of forecasting at the Kiel Institute for the World Economy who was quoted by Retuers earlier this month as saying that
"...the problem is that the ECB has taken the pressure off governments."
Indeed there is an argument to be made that the central bank has no place stripping the market of the ability to punish fiscally irresponsible governments. If the market cannot apply pressure, where will the motivation to reform come from? Indeed the Bundesbank argues that it is appropriate and desirable for some eurozone countries to pay more to borrow than others:
"The risk premia reflected in interest rates shouldn't be mostly levelled."
As long as this rhetoric persists investors shouldn't buy into so-called 'relief rallies' in European equities (NYSEARCA:FEZ) and European debt. Such optimism will prove short-lived.