Win Win for Bonos amp BTPs

Chatter emerging that the stress tests on Spanish banks may find a shortfall of €120-140bn, double the consensus of €60bn-€70bn.

Also watch for any subsequent statements from the credit rating agencies, as these could reiterate or adjust their credit outlook as well as potentially force the hand of PM Rajoy to seek a formal request from the ECB.

Earlier this week we asked whether the euro and Spanish equities would be boosted by a win-win reflexivity among traders, whereby the decision to seek a formal request triggers the advantages of Outright Market Transactions (bond purchases, falling yields & propped up equities and stabilizing euro) and the lack of request, could be justified by an “all-clear” interpretation. The latter scenario is the least likely.

Spanish Prime Minister Mariano Rajoy’s “spending cut budget” will slash an extra €13bn from the 2013 budget. These could ease the way for liquidity assistance from the ECB’s OMT as the savings are in line with the bulk of the pre-conditions required by EFSF/ESM bailout.

From a technical perspective, Spanish and Italian bond yields suggest a bullish Q4 may be in the works, with further declines in the yields of bonos and BTPs. Monthly charts illustrate negative momentum conditions for bond yields over the next 2-3 months. This argues for another 10%-12% decline in Spanish 10-yr yields, nearing the 4.90% territory—following a 25% decline from their July highs. For Italian 10-year bonds, already down 26 % from their July highs, the downside target stands at 4.8% from the current 5.95%. If these charts materialize, they could well fall in line with constructive technical set-ups in EUR/USD, EUR/JPY and IBEX-35.

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