Thursday, January 13, 2011

Portugal debt auction goes well...

Risk assets took heart overnight following the successful sale of Portuguese bonds. Had the auction failed a bailout would not have been avoided and would have been a bad omen for bond auctions in Spain and Italy tonight.

In the end there was “healthy” demand for the Portuguese debt. The 10-year notes were sold at a yield of 6.72%, below the prevailing yield of 6.85%. The yield had been at 7.3% earlier in the week and had only rallied on the back of ECB purchases earlier in the week and comments from China and Japan that they would support sales of European bonds later this month by the European Financial Stability Facility (EFSF) to support the bailout of Ireland.

So far so good then. It remains to be seen if Portugal seeks a bailout – if for no other reason than sourcing cheaper debt via the EFSF rather than raising funds themselves.

Remember all this is simply dealing with the symptoms of a larger problem. The issue is bigger, even than fiscal consolidation and sustainability at the individual country level. It’s actually about fiscal solidarity at the European level.

With the bonds about to be issued by the EFSF, we are seeing the birth of a truly European bond market. A Europe-wide bond market and the lower interest rates and stability that would come with that, at least for the currently troubled peripheral European nations, seems the only pathway to fiscal sustainability and stability for those countries. It might also end up stopping what is currently a peripheral-Europe problem from becoming a core-Europe problem.

Over time that will drive a convergence of fiscal policy. There's nothing like peer pressure and grumpy neighbours to encourgae getting your (fiscal) house in order. This will be helped along by the tougher budget rules, and appropriate penalties for breaking those rules, that is currently being proposed by the ECB and considered by the European Parliament. Go you good things.