Chilly Tests Loom for Euro Zone Bonds
January in the northern hemisphere is usually the coldest month of the year and it might prove to be a bitter one for euro zone governments trying to raise money in the capital markets.
The first month of the year tends to be one of the busiest for government bond issuance as debt agencies seek to “front-load”, or sell a large amount of bonds early to get a head-start in their borrowing programmes.
Banks forecast euro zone nations could attempt to borrow up to €80 billion ($106 billion) in January.
The European Union and the European financial stability facility, the euro zone’s bail-out fund, are likely to be in the market for up to €13 billion to go towards the Irish bail-out. This is at least double the amount of the pre-financial crisis era, when debt loads were much lower.
RBS forecasts gross debt issuance in bonds will be €814 billion in 2011, with up to 10 percent of this likely to be raised in January. For this reason, it could prove to be one of the most difficult starts to a year for a long while.
Many investors are already boycotting peripheral euro zone government bonds. Any further stresses could see these markets grind to a standstill, forcing the cost of borrowing for these countries even higher.
The costs of borrowing, or yields, have been pushed sharply higher in the peripheral bond markets since October when politicians announced plans to make investors share the burden of potential debt defaults once the current eurozone bail-out mechanism expires in 2013.
This eventually saw Ireland forced to seek emergency loans and sparked worries that Portugal, the next country in the line of fire, would have to follow Dublin and Greece into the emergency room.
Don Smith, economist at broker Icap, says: “It will be an interesting month. We could see the crisis in the eurozone intensify as investors will start focusing on whether Portugal and even countries such as Spain will be able to attract demand for their bonds.”
Portugal will be the focus as the country has to refinance €20 billion of debt by the middle of the year.
Strategists fear that it might be caught in a vicious circle where rising yields hit growth expectations, which then spark further rises in yields.
Most strategists expect Lisbon, which has seen its yields spike above 7 percent for 10-year debt in recent weeks, will be forced to seek loans from the EFSF early in the new year.
The biggest worry centres on Spain. Its debt market is much bigger than Greece, Ireland and Portugal combined, which means much more money would be needed to bail it out, stretching the resources of the €750 billion at the disposal of the EFSF, European Union and International Monetary Fund.
Spain has reduced the amount of bonds it needs to issue next year but, at €80 billion, according to RBS, it is still historically high. If yields keep rising, then Madrid will at some point be forced to accept assistance.
Italy could also get caught up in the crisis, which would prove even more damaging and raise question marks about the durability of the entire euro zone project.
It is the euro zone’s biggest debt market in terms of outstanding bonds and needs to issue €215 billion in bonds next year. Nearly €50 billion is needed to refinance or repay in maturing issues in February and March.
Italy has a big advantage over other markets because it has more domestic retail buyers than anywhere else in Europe. These investors are likely to continue buying Italian bonds, even in the face of a deeper crisis.
Events since Greece became the first country to seek bail-out loans in May show that no country, even Germany, can afford to be complacent. Germany has experienced lacklustre demand for some of its bond auctions, too.
The week starting January 10 is seen as potentially key as it is the first full working week after Christmas when a number of governments might try to rush out debt auctions to beat the expected dash to issue.
Nick Matthews, senior European economist at RBS, says: “Nothing can be ruled out in the eurozone. It will only take a few auctions to go poorly and that could hit sentiment and see a snowball effect.”
Another banker says: “That first?week?could make a big difference. If bond auctions are well received, they could boost sentiment and ease some of the pressures on yields. On the other hand, poor demand will see the reverse.”