Spain’s bond market signalled imminent crisis Wednesday as five-year bond yields climbed briefly above ten-year yields.
This inversion of the yield curve – longer duration yields falling below shorter issues – is a sign that investors believe risks are higher in the short term. Bond markets in Spain are telling policy makers that bailout decisions cannot wait.
Since 2007, inverted yield curves have been a definitive indicator of funding stress, an inability to borrow money at acceptable rates in the open market.
The market yield on sovereign debt is also the rate of interest a government must pay to lenders. In Spain for example, the 3.2 per cent jump in 10-year yields to 7.6 per cent over the past 12 months has vastly increased interest expenses for the financially-strapped government.
With a normal upward-sloping yield curve, when a government finds 10-year yields unpalatable it would issue shorter-term bonds where the rate is lower.
In crisis periods short-term debt issues are repeated until the market balks, sending short-term yields higher. When the yield curve inverts, investors are signalling a lack of trust the government’s ability to repay the principal on even short term debt.
The yield on two-year Spanish government bonds jumped 0.46 basis points this morning in a clear sign the market is reluctant to buy any of the country’s debt, regardless of term.
Spain needs to borrow a minimum €34-billion from fixed income markets in the latter half of 2012. With two-year yields at 6.25 per cent, they are running out of ways to accomplish this at rates they can afford.