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Today, Bank of Spain released its balance sheet data for April. My main observations are:

  • There was no meaningful resort to new net lending from Spanish banks during April.
  • Target2 liabilities increased by €32.4bn while reserves held at the deposit facility decreased by €35.3bn. In general, it seems that Spanish banks ‘financed’ outflows to the rest of the Eurosystem by decreasing their deposit holdings.
  • General government deposits maintained their strength, remaining at around €24bn (since January they have increased from €5.8bn to €10bn on February and €24.8bn on March).

In general, i maintain my previous projection that Spanish banks will face serious liquidity needs in the summer which will be reflected on the Spanish government finance. Large government deposits do provide a safety buffer.

On a related subject, today’s Spanish T-Bill auctions went rather awful. 12-month bills yield settled at 2.985% (compared to 2.623% at 17 April last auction), while 18-month yield closed at 3.302% (last 3.110%). The yield curve for Spanish debt seems to be ‘inverting’ on short-term debt (in the sense of short-term zero rates increasing much more than long-term rates and driving the latter), especially compared with current yields on AAA securities. The following yield curve from ECB better illustrates this point:

Personally, i cannot see a way out for ECB apart from engaging into a large enough QE for Spanish and Italian debt, probably combined with a recapitalization scheme for Spanish banks financed by the EFSF.

The situation is quite obvious in the following chart where the latest Treasury auction results are charted against Eurepo rates (for maturities up to one year) and Dutch bonds (for maturities over one year), which i think represent the ‘risk-free’ yield curve better than German bunds (which carry a safe haven/liquidity premium):

The market is clearly projecting an event in the following 3 years, with the likelihood of it happening within a year quite elevated.

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Kostas Kalevras

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