Spain, Italy Face Continuing Risks

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Marc Chandler

NEW YORK ( BBH FX Strategy) -- The more Spanish officials talk about the budget, the less credible it seems. The 10-year yield fell 11 basis points on Friday when the budget was first presented before the weekend. Now as more detail emerges as it goes to parliament, 10-year yields are rising.

The budget assumes that yields will remain around February levels. The 10-year yield averaged a little more than 5.10% in February. It averaged 5.20% in March. Yields rose in the second half of March and are now near 5.40%.

This raises alarms that Spain is underestimating its debt-servicing costs. Spain plans on selling as much as 3.5 billion euros of debt tomorrow with maturities ranging between three and eight years. Some concession ahead of the auction may also be a factor weighing on bond prices today.

On top of this, the problems of Spanish banks are likely to spill over and hurt the sovereign. As the banks address the rising nonperforming loan problems stemming from the real estate bubble, their appetite for Spain's sovereign debt may wane. Note that house and land prices are still falling.

Meanwhile, Spain reported Tuesday yet another increase in those registering for unemployment benefits. The March increase was 0.8% but is now 9.6% above year-ago levels and rising.

It may seem a bit ironic, but Spain does not report unemployment rates. The 23.6% unemployment rate in February is a calculation from the EU's stats agency. Spain has yet to cut its public sector work force, while the private sector continues shed workers. This seems likely to change.

Despite what has been advertised as the most austere budget since Franco, the real commitment of Spanish officials remains questionable. Last year's deficit was overshot by 2.5% of GDP.

To appreciate this magnitude, note that the Stability and Growth Pact required deficits to be limited to 3% of GDP barring unusual circumstances. Although these are unusual circumstances, the overshoot itself was large. Then Prime Minister Mariano Rajoy unilaterally loosened the target this year from 4.4% of GDP to 5.8%.