How To Play Spain?

In this week's episode of the never-ending "Who's Going To Default This Week?" sitcom, our contestant is Spain, who is fresh off electing a conservative supermajority in a landslide over the weekend, led by Mariano Rajoy. Nobody was really expecting anything different, but when your opponent comes into office in 2004 with 2 million unemployed an exits with 5 million, you don't have to run much of a campaign to oust them.

Things weren't looking so good for Zapatero and the Socialist Party. If you thought American unemployment was bad, check this out: Spanish national unemployment stands at 21.5%, and the youth rate is around 45%.

So naturally, investors being the rational human beings unaffected by emotion that they are, the debt crisis there now shows signs of stabilizing.

Wait, no it isn't! Following yet another panic sell on the major global indices, Spanish debt yields spiked (the 3-month rate to 5.1% from 2.3%, the 6-month rate to 5.2% from 3.3%) at a recent auction. Even the 10-year rate took a leap to 6.64% yesterday, only slightly below Italy. A 7% borrowing rate as a lot of us know, is considered unsustainable.

If you're trading bonds in this environment, how do you react? How best to take advantage of the fear and hysteria? Sure, you could just bail immediately and take your losses, or go short--but will it look like a stupid move if the following week the panic subsides, as with the Italian crisis? In this case, it becomes a question of market timing--are you really that good? Or is it really different this time, and the first default in the EU will happen not in Greece, but in Spain?

Or maybe something a little more nuanced? How would you profit in a situation where it looks like Spanish and Italian debt yields could converge? How does the inverse relationship between yield and pricing help here? How would the ECB affect your decision? Keep in mind these are the kinds of questions that could come at you in an interview.

Have at it, monkeys! That's the situation; now explain where the profit is to be had.