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panish and Italian debt is edging closer to a number of triggers that could take the eurozone crisis to a new peak.
Spreads on the eurozone’s third- and fourth-largest economies – the premium they pay to borrow over Germany – hit 404 basis points for Spain and 384bp for Italy on Tuesday.
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hat edges both countries closer to higher margin calls for Europe’s biggest clearing house, LCH.Clearnet, a move that has previously deepened market problems for other peripheral eurozone countries.
LCH imposes an additional margin requirement of 15 per cent when the yield spread rises above 450bp.
“These spreads are not sustainable … Something has to give,” said one senior European capital markets banker.
But LCH’s spread refers to something more than the simple premium a country pays to borrow over Germany. Instead, it refers to the premium to a triple A European benchmark, which also includes France and the Netherlands.
This is significant because French yields in particular have decoupled from German ones in a meaningful way in recent weeks. The French spread over Germany hit a new record on Tuesday of 76bp. That should give Spain and Italy some additional breathing room.
LCH also makes clear it can change the margin requirements because of credit default swap prices. Prices of Italian and Spanish CDS, which are supposed to give investors protection in the case of default, hit fresh records on Tuesday as well, with Spain at 420bp and Italy 368bp.
Analysts are worried that the thin trading in August is likely to see Spanish and Italian yields continue to drift higher unless there is concerted action from European leaders.
Laurent Fransolet of Barclays Capital points to the risk that higher bond yields lead to downgrades from credit rating agencies, which leads to higher yields and then further ratings action and higher margin payments - or charges - from clearing houses that guarantee investors’ trades.
“You are into this vicious circle already,” he says. Both Irish and Portuguese yields shot up after LCH imposed extra margins for their debt in recent months.
Italy and Spain are also at risk on the ratings front after both were warned last month that they could be downgraded, in part because of higher funding costs. Spanish and Italian 10-year yields hit fresh euro-era highs of 6.45 per cent and 6.25 per cent, respectively, on Tuesday.
That brings them closer to another trigger seen by some investors: a 7 per cent yield. Although many market participants say there is no particular meaning behind such a high absolute yield, 7 per cent has acquired particular significance for those who think it marks the level at which 10-year government debt becomes unsustainable.
Portugal, Ireland and Greece – the three eurozone countries so far to be bailed out – have all struggled to issue new debt once their yields breached that level. Their rescues also came within days of yields going above 7 per cent.
