by Anthony Mirhaydari | March 7, 2011 12:26 pm
If you were wondering what the next shoe to drop was, well here it is: The European Central Bank’s “strong vigilance” against rising inflation will likely result in higher interest rates as soon as next month.As a result, a short in Spain bank Banco Santander (NYSE: STD) may be wise.
I talked about this inflation and interest rate risk in my last blog post on MSN Money. But here’s the kicker: This will tighten the noose around Portugal, forcing that country to follow Greece and Ireland in accepting an EU-IMF bailout package. Also contributing is a failure by Europe’s political leaders thus far to agree to an expansion of their sovereign rescue fund, the EFSF.
The mechanism for action will be higher bank funding costs via higher interest rates and higher loan losses as the eurozone struggles under the export-limiting influence of a stronger euro which is up nearly 16% against the dollar since January. A stronger currency, according to Capital Economist chief European economist Jonathan Loynes, is that “last thing the already uncompetitive peripheral economies would appear to need.” And all of this will call into question the solvency of Spain — a country so large that the eurozone’s rescue fund may not be able to save it.
Markets are already starting to discount the possibility of another round of trouble. And for good reason.
Portugal’s 10-year bond yield is flirting with fresh highs near 7.5%. Both Ireland and Greece didn’t last long after their borrowing rates moved over 7%, as higher funding costs forced them to take cheaper bailout funds. The price of Portugal’s credit default swaps have also returned to levels seen during Ireland’s bailout fiasco back in November.
In Ireland, a new center-right government led by the Fine Gael party wants to renegotiate the terms of its EU-IMF bailout and is putting pressure on private bondholders to accept losses. Finland’s finance minister also added support for private investors sharing in some of the debt bailout consequences.
Credit analysts are becoming increasingly nervous. Today, Fitch revised down its outlook for Spanish debt from stable to negative due to the “potential for an intensification of volatility and stress in European financial markets” if Europe’s leaders can’t agree on a comprehensive package of reforms to solve the debt crisis at the EU summit on March 24 and 25. But some of the risks are already baked in with the negative outlook reflecting “a weak economic recovery, banking sector restructuring, and fiscal consolidation, especially by regional governments.”
All of this is starting to weight on Europe’s financial stocks — which are on the front lines of the crisis since they are major holders of eurozone sovereign debt and would take hefty losses in the case of debt restructuring or default. By favorite short idea, which I’ve recommended to my newsletter subscribers, is Banco Santander (NYSE: STD), which is down more than 6% in the last week as it falls out of a three-month consolidation range. STD is a Spanish bank with heavy exposure to both Spain and Portugal.
Disclosure: Anthony has recommended a short in STD to his newsletter subscribers.
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