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Some thoughts on Spain and a Spanish bailout

There are continuous rumours and speculation that a Spanish bailout will be announced in the coming weeks.

However there are a number of problems in this happening.

Firstly the market is missing a big problem with this- there are no funds available for a bailout from the ESM.

The ESM currently has €32bln in capital. But not much of this can be used to buy Spanish debt- the Capital is restricted to buying Government debt predominantly rated AA. So with S&P rating Spain BBB- and Moody's at Baa3, for every €1 of Spanish debt it could buy, it would need to buy €5 of AAA rated bonds. So that wouldn't be a very good way to leverage the capital. The only way the ESM could offer a bailout is if it raised funds in the open market. But at the moment the ESM has not announced any plans for a bond issue. Given the size of the funding needs the ESM would have to schedule a number of meetings globally with investors so that credit lines can be arranged. None of these have been announced as of yet. Time is running out for meaningful financing to be arranged this year. The ESM will not want to be forced into issuance in December, so it will need to launch a deal in November and that would need marketing now. Even so, if Spain did need the ESM to provide financing before the end of the year, it is likely to lead to a rise in yields of the core sovereigns. That will not sit well with the German press. There is a possibility that the ESM could issue short-term debt, Bills, to finance a Spanish bailout if requested, however this would not be an ideal financing method and would likely be resisted by some board members of the ESM.

I continue to believe that the ESM was never meant to be used for a new bailout- it was just supposed to be the Big Bazooka aimed at the markets which politicians believed the markets would never force to be fired. This is the same as the ECB's OMT.

Secondly-There is a real risk that Spain will break up under the strain of the austerity plans.  Spain has local regional elections this weekend in  the Basque Country and Galicia. and then on November 25th in Catalonia. All are likely to see a weakening of the Rajoy administration. Certainly the Spanish government will not want to go into the Catalonian elections after having announced an ESM bailout. The Catalonian election is set to cause a constitutional nightmare for the Rajoy administration as the Catalonia regional leader looks likely to strengthen his support.   He is then set to announce plans for a referendum on Catalonian independence for 2014. Artur Mas is set to use the Scottish example to further his case. If Catalonia does announce a referendum then it is almost a given that the Basque separatists will announce similar plans. With two major Spanish regions potentially seceding from Spain then it would become impossible for the ESM to announce a bailout plan for a country that it would not know would even exist in its current form in 18 months time. Remember when Greece announced plans of a referendum on the Austerity measures last November the politicians in Europe would not allow it and threatened to pull out of the agreed bailout.

So, the chances are slim that Spain will request a bailout in 2012, and there is an increasing probability that Spain will never be in a position to request a bailout.

The next 2 months are set to be another very volatile time for the Eurozone. The Euro must therefore come under renewed selling pressure. With FX Option Implied Volatilities  at relatively low levels a 3 month option to sell the Euro here against SEK, as JPY and USD will have their own issues in the coming months. looks attractive.

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