Spanish Bond Yields Soar, Equities Sink

The pain in Spain appears to be about to get worse. Yields on 10-year government bonds rose 22 points to 5.93%, following an announcement from the Catalonia region that a new election that is widely seen as a first step in declaring Catalonia's independence from Spain.

Spain also is reeling from a decision by finance ministers from the Netherlands, Finland and Germany that any future bailout of Spain's banks will not include assets that were recapitalized before the bank supervision system goes into effect. That is not what Spain expected.

Further, pressure is mounting on the Spanish government to ask formally for a bailout. The country's president is scheduled to deliver his budget message tomorrow, and the expectation is that Spain will report that it has missed its agreed upon deficit reduction target. The president is expected to spell out the government's latest fiscal reform measures as well.

Just as the bond market reacted by demanding a higher risk premium, so too did Spain's equity market react - except in the opposite direction. The IBEX 35 index has fallen more than 3% so far today.

Spain's budget deficit for the first eight months of 2012 totaled 4.8% of GDP, against a full-year target of 6.3%, down from the actual deficit of 8.9% of GDP in 2011. And the harder the government tries to lower the deficit, the more pushback it gets from regions like Catalonia, Andalusia and Valencia.

Paul Ausick

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