Things were looking up for Spain June 7 yesterday after the country conducted a surprisingly successful bond auction. The New York Times reports that the Spanish treasury sold 2.1 billion euros (2.6B USD) worth of bonds, which was higher than anticipated due to an unexpectedly strong level of demand. Offered at the sale were two short-term note options with maturities of two and four years, as well as 10-year maturity bonds.
Despite the success of the auction, Spain still faces the obvious harrowing downside: interest rates. During Spain’s last auction in April, the 10-year coupon rate was listed at 5.74 percent. Yesterday, that number crept up to 6.04. Further fueling this increase was a chop in the country’s credit ratings that sparked a sharp interest rate rise to 6.177. While the interest rose, Fitch Ratings new label on Spain that was based on speculation of an imminent bailout for Madrid, brought down their credit rating from A to BBB.
The big taboo stigmatism here is that by being classified in “BBB” status, Spain is now just two paltry steps from “junk bond” status.
Junk bond status? That illustrious name sounds like a pretty trust worthy and secure investment option if I’ve ever heard one.
But, before letting their unbecoming title fool you, know that this classification of bond happens to possess the appealing ability to provide investors a substantially higher yield than a traditional investment grade bond. This being due to the fact that a borrower with scathed credit gets to a point where they have no other option for obtaining needed capital; hence they must succumb to paying the lender a much higher amount of interest. Of course, there are risks that need to be assessed prior such as the possibility of the borrower defaulting.
For now, bonds will provide strength to Spain’s economy, but this isn’t a long-term solution. Given that Spain did rely solely on the sell off of their hefty debt, with interest rates as high as they are, the potential for their situation to transition into a full blown government-debt crises becomes very realistic.
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