Well, so much for costly European efforts to build a protective fence around dangerously vulnerable members of the euro zone. The bond market continues to pummel Spanish and Italian bonds – while driving German yields to record lows – amid fears that embattled governments will not get their fiscal houses in order and the European Central Bank's moves to prop up the region's ailing banks will not be sufficient.
The bond market's renewed aversion comes at a particularly bad time. Euro zone governments will to have find takers for more than €1-trillion worth of debt this year, and European banks face bond redemptions of more than $600-billion in the first half of the year alone.
In response to the market resistance to everything Spanish – the yield on the benchmark 10-year government bond hit its highest level in nearly five months Tuesday – Spain's government has gone back to the old euro zone playbook. Madrid has unveiled further steps to tighten fiscal policies and is promising additional structural reforms and faster consolidation of the financial sector. The revised package will include slashing more than €10-billion from spending on health and education – hardly a recipe for recovery from a deep economic slump.
The real test will be whether Madrid can effectively rein in spending by regional governments, which account for a big chunk of the social outlays, at a time when the economic outlook is particularly bleak. Barclays economist Antonio Garcia Pascual notes that "market confidence will only be restored" if both Madrid and the regional governments show that they are adhering to the tougher fiscal regime and are on track to meet the ambitious national deficit target of 1.5 per cent of GDP in 2013.
It's a tall order, and the bond world is plainly casting a negative vote.