European equities rallied, euro/$ rate jumped over a percent and Spanish 10-year fell by 45bp. All thanks to comments by Draghi at a pre-Olyimpics Global Investment Conference in London this morning.
What did Draghi say? Two things, (1) “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough” and (2) “To the extent that the size of the sovereign premia hamper the functioning of the monetary policy transmission channel, they come within our mandate”.
While the timing of Draghi’s comments came as a surprise, the fact that he talked about euro and sovereign premia did not. In fact, investors were expecting it to come imminently. The simple reason is that every time Spanish yield rose above 6%, there had been some form of reaction from European policymaker, verbally or otherwise, to push the yield back to below 6%. The only difference has been that the pain threshold leading to the reaction has steadily increased over time.
The first time Spanish yield rose over 6% was in July 2011, just a year ago. It rose steadily going into the European Banking Authority (EBA) stress tests results on July 15, 2011. When the results came in, only 8 banks failed and a mere €2.5bn of new capital was required. That along with positive comments on Greece rescue plans ahead of the July 21st EU Summit started to push Spanish yield lower. As such, the auction of Spain’s 18-month T-bill on July 19th was over-subscribed. The EU Summit confirmed investors’ expectations. At the Summit the leaders attempted to prevent Greek contagion from spreading to other peripheral European countries by providing additional help to Greece (extending the maturity of new EFSF loans and significantly lowering interest rates) and allowing the EFSF to buy bonds in secondary markets.
The second time Spanish yield rose over 6% was in November 2011. Again, concerns over the European project rose and reached a peak when the German bond auction was under-subscribed on November 23rd. Again, policymakers started to make noise going into the December 9th EU Summit, which helped push Spanish yield lower. Essentially, the debate started to move towards a fiscal union. The summit confirmed the rumors. They agreed on principal on a fiscal union but did not flush out the details.
This time Spanish bond yield jumped over 7% on concerns that regional governments are seeking financial aid from the central government. On July 22, Bloomberg reported that, “Catalonia May Follow Valencia in Bailout Request”. As the pressure kept building on Spanish bond, the market was waiting for some form of reaction from policymakers and they got one today.
The rally in risky assets is likely to be short-lived because it is short-covering.
