Spain's funding costs are set to fall at auction on Thursday after Moody's affirmed the country's investment-grade credit rating and as markets expect Madrid to ask for aid soon.
The Treasury plans to raise 3.5 billion to 4.5 billion euros ($4.6 billion-$5.9 billion) in an auction of three bonds maturing in 2015, 2016 and 2022. Results of the auction will be published at around 0840 GMT.
The auction comes on the heels of a successful T-bill sale on Tuesday, when the Treasury sold more short-term paper than expected at lower rates than a month earlier.
Levels in the secondary market, considered a good guide to primary auction results, showed that while yields had eased on all three bonds since they were last sold, the longer-term issue remained under the most pressure.
"The supply should be well-covered, especially the shorter-term bonds. But our focus will be on the 10-year, which has seen fairly weak demand, and the effect of Moody's," rate strategist at RBS Harvinder Sian said.
"The market is still looking for the timing of the aid request, but the danger is that if the market continues to rally the Spanish government holds off (from appealing for help)."
Spain is the most recent focus of attention in the almost three-year-old euro zone debt crisis and has seen premiums on benchmark debt soar to near unsustainable levels on concerns Madrid cannot control its finances in the midst of a recession.
Madrid is under growing pressure from investors and many European counterparts to ask for aid from the rescue fund in order to trigger a bond-buying programme by the European Central Bank. The ECB buying will focus on maturities of up to three years, which may also explain part of the pressure on Spanish longer-term yields.
The country dodged a bullet late on Tuesday when ratings agency Moody's left its sovereign debt rating one notch above junk, in line with that set by rival Standard & Poor's.
But even Moody's suggested it should seek aid, saying: "the combination of euro area and ECB support and the Spanish government's own efforts should allow the government to maintain capital market access at reasonable rates."
The premium investors demand to hold Spanish over German debt fell to its lowest level since April on Wednesday, though uncertainty over when Prime Minister Mariano Rajoy will ask for aid meant the difference held at around 400 basis points.
Spain has been ready to ask for euro zone help since the beginning of the month via a precautionary credit line, European officials have told Reuters. But the request has been delayed due to German reluctance to sign off on the accord, sources say.
Of the debt on offer on Thursday, the bond due July 30, 2015 was trading at around 3.2 percent on the secondary market on Wednesday, compared to an average yield of 3.676 percent at its last primary auction Sept. 6.
The bond maturing Oct. 31, 2016 also saw support, trading at around 4 percent compared to 4.603 percent on Sept. 6, while the 10-year, due Jan. 31, 2022, was trading 5.5 percent, just below the average yield of 5.666 percent on Sept. 22.
Political uncertainty continues to plague Rajoy, with regional elections in Galicia and the Basque Country on Sunday and the Nov. 25 election in Catalonia where pro-independence sentiment is heating up.
Meanwhile, analysts are increasingly doubtful Spain can meet its deficit targets amid a deepening economic slump, rising debt costs, high social security bills from pensions and record levels of unemployment.
For investors, the possibility of ECB intervention in the secondary market if Spain requests help continues to support the Treasury's outings into international markets.
"Despite the concerning fundamental backdrop, we see little evidence that tomorrow's supply should go anything but well. The market remains broadly supported by the credible ECB backstop provided Spain requests conditional aid," Citi said in a note to investors.
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