Bond markets have renewed their attack on Spanish and Italian debt, signalling a lack of confidence that European leaders are close to corralling the spreading debt crisis.
Spain's borrowing rates soared to record levels Tuesday and a raft of Spanish banks suffered fresh credit downgrades, amid worries that the €100-billion lifeline tossed to Spain's floundering banks will worsen Madrid's own dire financial straits while proving no tonic for the increasingly vulnerable banking system.
"In the eyes of the market, all that has changed with the bailout announcement is that Spain will get the money from the Europeans at a lower rate instead of having to borrow it in the market," said Beat Siegenthaler, senior foreign-exchange strategist with UBS in Zurich. "All the rest remains the same, including how exactly the banking issues will be addressed."
The market response reflects general disillusion with the Europeans' handling of the entire crisis and the ongoing flight of capital, said Arthur Heinmaa, managing partner with Toron Investment Management in Toronto. "What you're getting are slow-motion bank runs. The banks can't sell their assets fast enough [to keep up with the loss of deposits]."
The yield on the 10-year Spanish government bond climbed above 6.8 per cent at one point, the highest since Spain joined the euro at its inception in 1999, after Fitch Ratings cut its ratings on 18 Spanish banks.
By the end of the day, the benchmark bond rose 20 basis points to 6.71 per cent. The bond-rating agency sharply downgraded Spain's sovereign debt by three notches last week to triple-B, citing the deteriorating economy and worsening fiscal outlook. This is putting further stresses on the banks, particularly those heavily exposed to the battered Spanish real estate market. Non-performing loans are rising, business volumes are falling and margins are being squeezed.
"This solution is still some way off," Credit Suisse said in a note to clients. "Spanish GDP could end up falling another 5 per cent on account of fiscal tightening … bank deleveraging and falling wages. This will have a negative impact on the fiscal arithmetic and credit quality."
"We think Europe is only half-way through resolving the crisis," the Credit Suisse analysts added. "In particular, we believe that we will need an ECB [European Central Bank] deposit guarantee or a €2 trillion five-year [long-term refinancing operation]."
The fog surrounding Spain is also costing debt-ridden Italy dearly, as its economy slides deeper into recession and it is forced to borrow additional billions of euros to cover its 22-per-cent share of the Spanish bank rescue tab. "There is a permanent risk of contagion," Prime Minister Mario Monti told an economic conference during the weekend.
The yield on 10-year Italian sovereigns reached 6.3 per cent, the highest since Jan. 25, before settling to 6.17 per cent, an increase of 14 basis points. Rising costs raise the spectre that both Spain and Italy – like Greece, Portugal and Ireland before them – will find themselves essentially shut out of the capital markets. But unlike those small countries, Spain and Italy are simply too big to bail out.
Madrid has been calling for a euro-zone banking union with a single regulator, the capacity to refinance troubled banks, and deposit insurance to cover euro accounts in any member country.
Without such a euro-wide deposit guarantee, banks in Greece, Spain and other battered countries face a continuing leakage of money. With such a backstop, even Greeks might be confident enough to leave their money in local banks, knowing they will be reimbursed in euros, regardless of whether Greece leaves the monetary union.