Spain's Treasury, known as the Tesoro Publico, will auction between €1.5 and €2 billion ($2 to $2.6 billion) in two- and ten-year bonds on Thursday. Spanish bond auction results are typically released between 4:30-5:30am New York time (08:30-09:30 GMT). As I mentioned in this post, there's been a lot of recent media attention and market chatter devoted to this bond auction.

Those with a pessimistic view towards tomorrow's auction are concerned that the Spanish banks, prominent recent buyers of their country's debt, could have limited scope for more bond buying. The Financial Times reported on Tuesday that Spain's banks may have already burned through their ECB LTRO funds:

Deutsche Bank analysts estimate that domestic Spanish banks have surpassed their capacity for buying their own sovereign debt. Between December 2011 and February 2012 Spanish banks purchased €61bn in domestic bonds, which according to Deutsche, means they have already surpassed their allotment from ECB loans by about €7bn.

A Bloomberg articlesummarized a Bank of Spain report released on Wednesday which showed that the ratio of non-performing loans to total loans at the country's banks has risen to 8.16%, highest level since 1994.

The appetite of Spanish banks and other investors for the 2-year paper, or Bonos del Estado, could prove more important than for the 2022 maturity. Simone Foxman (@SimoneFoxman), markets reporter at The Business Insider's Money Game, suggests in this article that the Tesoro Publico is likely "pandering to the cheap cash banks have because of the [ECB's LTROs]" as it has recently issued much more short-term debt. She illustrates the uniqueness of the Spanish Treasury's year-to-date issuance profile versus the prior two years with this graph:

Dave Sekera, senior securities analyst with Morningstar, explains in this piece that the short end of the Spanish yield curve is a better gauge of the near-term risk of a Spanish default:

The credit curve has been shifting upward, but the rising yield of the 2-year bond has not outpaced the increase in the 10-year bond. Yield curves flatten when the credit markets price in an increasing probability of a near-term default, as investors require higher short-term yields to compensate for jump-to-default risk. In Spain's case, while the market is pricing in higher long-term default risk, it is not yet pricing in substantially higher near-term default risk.

Bottom line for currency traders: As I type this post, the EUR/USD currency pair is stuck near the middle of a roughly 200-pip trading range defined by the 1.30 and 1.32 psychological levels. If the auction shows higher yields and lower demand than those seen at the previous 2- and 10-year bond auctions, the euro could feasibly finish the London trading day with a sub-1.30 price. On the other hand, a well-received offering could ultimately lift the EUR/USD to a 1.32 or 1.33 handle.

Although the market will likely focus more on Spain for now, I’m also keeping an eye on the French bond market. That country is auctioning short- and medium-term bonds on Thursday as well.

Curt Wehrley
Twitter: @fxcoachcurt
Currency Coach & Quantitative Analyst
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