Crossing the Pyrenees

Two weeks after a rather mediocre debt auction renewed Spanish jitters, demand for Spanish sovereigns seems to have rebounded—Thursday’s offering saw decidedly robust demand. Spain sold €2.5 billion—€1.1 billion of 2-year bonds and €1.4 billion of 10-year bonds—with demand of 3.3 and 2.4 times coverage, respectively.

Two-year yields fell a teensy bit from the previous auction (October), but 10-year yields rose 0.34 percentage point from the most recent auction, in January, to 5.743%. Some commentary bemoaned the latter, suggesting it means investors are concerned about Spain’s deficit reduction commitment. This was perhaps exacerbated by a separate report from Moody’s, which warned “borrowing costs above 5.7% will significantly raise the chance of default.” As always, we view any proclamation from a ratings agency with a bit of healthy skepticism. Moreover, though higher borrowing costs certainly aren’t great for Spain, there’s no evidence 5.7%, 6%, 7% or any other arbitrary number is inherently an automatic tipping point.

Consider: Spain has already met about 50% of its 2012 bond issuance target, including 76% of its longer-dated maturities (to us, a more significant hurdle), and it’s only April. This should let Spain’s Treasury target smaller amounts at the year’s remaining 16 auctions, helping mitigate the budgetary impact of higher yields (if yields remain elevated). In our view, this reinforces the notion that Spain’s 2012 auctions needn’t be stellar—even ok results should beat uniformly dour expectations and allow Spain to meet its funding needs. Plus, the ECB’s secondary-market bond purchasing program remains paused, but officials have said it’s still an option. It’s likely the bank will act if yields continue climbing, provided Spain remains committed to austerity and reform (which seems to be the case thus far).

France, too, had a successful offering on Thursday, selling €7.97 billion of two-, three- and five-year debt at yields of 0.85%, 1.06% and 1.83%, respectively. Aggregate demand was nearly thrice coverage, despite the two main presidential candidates seemingly doing their best to increase uncertainty in the run up to Sunday’s first-round vote. Incumbent Nicolas Sarkozy and his primary challenger, Socialist FranÇois Hollande, have made some rather funky proposals on the campaign trail. Sarkozy’s include a French financial transactions tax, a “Buy French” requirement for government purchases, closing France’s borders to European migrant workers and increasing apprenticeship quotas for large firms. Hollande, meanwhile, touts a 75% tax rate on incomes exceeding €1 million annually, a surtax on banks’ profits and lowering the retirement age to 60.

On the surface, each candidate likely offers markets plenty to stew over. But remember, they’re politicians, and politicians tend to moderate once elected. It’s entirely possible whoever wins backs off some or all of their more onerous proposals, and it’s far from certain France’s National Assembly approves any measures introduced.

France’s election has international significance, too, given Sarkozy’s prominence in the efforts to shore up the euro. Both candidates are pro-euro and pro-eurobond, but they differ over the fiscal compact. Hollande, the current poll-leader, has long favored renegotiating the agreement and this week announced he couldn’t recommend the National Assembly ratify it unless pro-growth measures are added. That’s caused some EU to-do, but the consternation seems a tempest in a teapot. Only 12 of 25 participating nations need to ratify the pact for it to take force; Slovenia, Portugal and Greece already have. If France doesn’t ratify, it doesn’t participate, but France’s abstaining shouldn’t impact the efficacy of an agreement that didn’t even seem terribly impactful or necessary to begin with. That said, if the eventual upshot is sensible common growth-oriented policy, the eurozone could benefit—but this is very much wait and see.

Most important, in our view, is this: Regardless of the victor on Sunday or the May 6 runoff, the French president likely remains dedicated to doing what’s needed to prevent a disorderly eurozone collapse in the period ahead.