Yesterday was another big day in the Eurocrisis – the Greek government looks set to fall, Italy’s is tottering on the edge and France announced (another) austerity package.
With Italian yields approaching the crucial 7% level at which a ‘bailout’ was required in Greece, Ireland and Portugal the situation looks pretty grim.
But for me the real news yesterday wasn’t the stuff which made most of headlines. Instead it was a much less reported debt auction by the European Financial Stability Fund (EFSF).
As CNBC report this auction was meant to take place last week and aimed, initially, at raising €5bn. Instead yesterday’s auction only raised €3bn and at a much higher rate than previously. The ten year bond will yield 3.59% against German borrowing costs of only 1.8%.
Poor demand is one factor, but others are pointing to concerns that France may eventually lose its AAA-rating. The EFSF is itself guaranteed by Germany and France (mainly), so if France is downgraded the EFSF could also be downgraded. That would make the cost of bond issuance prohibitive.
But it’s already getting prohibitive.
As recently as June the EFSF could borrow for 0.8% less.
This matters hugely. The EFSF is the Eurozone’s proposed ‘big bazooka’ but only if it can ‘leverage up’ – i.e. only if it can itself borrow cheaply to provide support to struggling sovereigns.
As Michael Pettis has noted China and other emerging economies are not especially interested in supporting it – for entirely understandable reasons.
If European leaders hope that China will lend large amounts of money directly to those borrowers, I say good luck to them but they shouldn’t expect too much. Why should China lend to someone who won’t repay?
The leveraged EFSF may still turn into a bazooka but so far it looks more like a water pistol.
If there is little investor demand for EFSF bonds then the whole Eurozone rescue plan – in as much as there is one – is in great jeopardy. Grim news indeed.