Spanish Bond Yields Top 6%, CDS Costs Rise

Spanish sovereign bond yields edged above 6 percent Monday as investors grew wary of the government's continued struggles to reduce the deficit and improve labor market competitiveness.

Bond yields of 6 percent or higher are seen as a psychologically important barrier, marking the point at which yields start to soar dangerously. In the cases of Greece, Portugal and Ireland, when bond yields exceeded 7 percent, the nations had difficulties raising liquidity in the markets, according to the New York Times.

The cost of insuring Spanish debt has soared in recent weeks, increasing 21.63 percent in the last in the last month and 5.75 percent in the last week, according to Reuters. Rising costs of credit default swaps indicate that investors and insurance writers consider Spanish debt to be increasingly risky.

Yields on bonds are inversely related to the perceived strength of the bond; rising bond yields are a sign that investors do not perceive Spain's debt to be healthy. Spain currently has a debt exceeding $1 trillion, and as yields on that debt have risen, the cost of insuring it against default through CDS has also risen.

The price of CDS on the benchmark 10 year Spanish bond has climbed steadily for weeks and reached 495 basis points on Monday, according to Markit, meaning that it costs $495,000 to insure $10 million of Spanish debt for one year.

Spain faces two simultaneous economic necessities which are driving the rise in bond yields. The nation must try to regain economic competitiveness while also seeking to decrease deficits and debt. Trying to solve both problems simultaneously results in a bind where measures to address one problem will exacerbate the other, a Goldman Sachs report said.

With a single [European] currency, regaining competitiveness [in Spain] relies largely on running lower inflation than the euro area average ... But stronger nominal GDP growth is needed to address fiscal problems and put public debt on a sustainable path. The low inflation (or deflation) required to regain competitiveness will exacerbate fiscal difficulties, the report said.

Spain so far has missed the mark in decreasing its government deficit. Spain's government announced that the deficit for 2011 will be approximately 8.5 percent, well above the official target of 6 percent, a March 2012 euro zone snapshot report from Fitch Credit Ratings said.

The failure to bring the deficit down to 6 percent means Spain will likely miss its 2013 goal of a 3 percent deficit, the Fitch report said.

Essentially, investors want Spain to decrease its deficit and debt, yet they fear that austerity measures will cripple economic growth and Spain's ability to pay those debts. The task of restoring a competitive economy and decreasing deficits and debt for Spain appears large, to the point of being insurmountable, the Goldman Sachs report said.

The necessary economic re-balancing in Spain is hindered by its rigid labor market, which has led to a significant destruction of human capital through the downturn ... Spanish labor market reforms passed in February could aid Spain's long-term recovery, the Fitch report said, but it cautioned that Spain's labor market remained rigid and less competitive than in other euro zone states.