Spanish economy shrinks, along with its borrowing costs

In the bizarre logic of financial markets, bad economic news continues to be viewed positively by many investors.

Spain is the latest example. The Spanish government released data Tuesday that showed the nation's economic recession deepening, yet borrowing costs continued to ease.

Spanish GDP shrank 0.4% in the second quarter, following a decline of 0.3% in the first quarter. The data confirmed a report released earlier this month from Eurostat that showed the overall eurozone economy shrank 0.2% in the second quarter.

Despite the disappointing economic performance, the Spanish government was able to sell €3.6 billion worth of three and six month Treasury bills Tuesday.

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Investors have been eagerly anticipating a major intervention in the bond market by the European Central Bank ever since its president, Mario Draghi, said last month that the ECB would do "whatever it takes to preserve the euro."

Draghi made it clear at his most recent press conference that the ECB is willing to buy shorter-term government bonds as long as the government in question requests support from one of the eurozone bailout funds.

Spain is widely seen as the most likely to benefit from an ECB intervention. Given its sluggish economy, high unemployment and troubled banking sector, many investors believe the Spanish government is on the path to needing a full-blown bailout similar to those given to Greece, Portugal and Ireland.

But the Spanish government has yet to tap the European Financial Stability Facility, the only functioning bailout fund pending the approval of the European Stability Mechanism. Until it does, the ECB cannot buy Spanish bonds, according to Draghi's ground rules.

Nevertheless, Spain's borrowing costs have come down significantly since Draghi's comments sparked hope that the ECB might buy more government bonds.

The yield on Spain's 2-year notes fell to about 3.7% Tuesday, down from a high of 6.6% in July. Investors appear to be taking Draghi at his word when he says the ECB will buy short-term debt.

Spain's longer-term bond yields have also declined from their July highs. The yield on Spain's 10-year bond steadied around 6.4% Tuesday, down from 7.6% last month.

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All of this suggests investors are willing to look on the brighter side of Spain's economic pain if it means the ECB is more likely to intervene.

This counter-intuitive approach to investing has been popular in the United States, where investors see weak economic data as a strengthening the case for more action from the Federal Reserve.

I guess we're not that different after all.

Posted in: bonds, economy, European Central Bank, recession, spain

Source & Image : CNN Money