Eurozone coming apart at the seams; Spain and Portugal deny need for bailout…..spreads indicate otherwise

Another day, another rise in PIIGS spreads.  A spread is just the difference in bond yield between one country’s bonds and a ‘benchmark’ country’s bonds.  In Europe, the benchmark is the German Bund, considered the most solid bond in the European union.

A spread of 4% indicates that one country is paying 4% more to finance their debts through their bond market than Germany is.

The spreads on the PIIGS bonds is extremely troublesome as it makes borrowing to fund their deficits more costly.  Of particular concern, notice the rise yield on the Spanish 10 years.

There is rising concern that the European debt issue is causing a domino effect whereby Spain and Portugal may also require bailouts as market force their borrowing costs higher. Though the IMF announced a 750 billion euro ‘shock and awe’ bailout package in June, jitters have continued to mount.  The 145 billion euro lifeline thrown to Greece was meant to calm nervous investors, and for a while it did.  You can see the sudden move downwards in Greek and Portuguese 10 year yields.

Yet since that time, bond yields have moved consistently upwards again, with Portugal and Spanish yields well above their previous June highs, while Greece marches steadily back towards those same highs.

By far the biggest concern at the moment is the rising possibility of a required bailout for Spain.  As Spanish bond investors seek increasingly higher yields, it chokes off economic growth to a nation that accounts for a 12% of total euro zone GDP.  Bad new for those hoping Europe will soon pick up the slack from our number one trading partner, the US.

Some simple math also tells us that a guarantee of all new Spanish debt over the next three years will amount to about 530 billion euros, easily consuming the bulk of the remaining bailout fund.  And that’s not accounting for the bailout needs of Ireland and Portugal (arguably the next domino to fall).

Though both Spain and Portugal have adamantly deny needing a future bailout, investors are increasingly seeing things differently.  In fact, the notion of a euro zone break up or at least a restructuring of existing debt is increasingly being discussed.

What does this mean to us here in Canada?

As I’ve been saying for some time, I do think that a capital flight out of Europe will be bullish for the US dollar and bearish for commodities over the near term.  I would have thought that it would also be bullish for bonds in ‘safer’ countries such as Canada, but recent price movements have me questioning this thesis.

It also means that a weakening euro and slack demand will cut into out exports to the euro zone, though a strengthening US dollar may pick up some of that slack.

Regardless, the near term outlook for commodities (except monetary metals like gold and silver) remains very cloudy.  With a growing bubble in China that their central bank is actively trying to reign in, coupled with ongoing euro zone tensions and extremely high net spec long positions in most commodities, I have to believe that the near term outlook for these commodity prices and the TSX by association remains bleak.

Cheers

Ben

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5 Responses to Eurozone coming apart at the seams; Spain and Portugal deny need for bailout…..spreads indicate otherwise

  1. jesse says:

    “I would have thought that it would also be bullish for bonds in ‘safer’ countries such as Canada”

    It’s hard to think that getting a 2% yield on Canadian paper would be preferred over getting 5% on something else. At some point the “flight to safety” is overbought.

  2. LRM says:

    I sure noticed the price decline in XSB this past month even though it is short term and should be less volatile. I have seen the logic that if one holds to the weighted average duration of 2.63 years then the expected weighted average yield to maturity should be obtained but still it is less than reassuring to see a capital decline on the amount invested .

  3. breezer1 says:

    the world appears to be rapidly approaching a ‘ blood in the streets ‘ moment.

  4. El Magnifico says:

    Hey Ben,

    Following one of my comment made on an earlier post, I would suggest you to write a post about the middle class in America and Canada, and how it has been affected not only since the recent financial crisis, but since the global free trade agreement (GATT).

    Here is a series of quite interesting statistics explaining what’s happening to the middle class:
    http://www.businessinsider.com/22-statistics-that-prove-the-middle-class-is-being-systematically-wiped-out-of-existence-in-america-2010-7
    http://www.businessinsider.com/facts-about-inequality-in-america-2011-11

    Why middle class? Because its size and wealth determines whether a country is a developed or developing (emerging) country. While some countries are on the path of becoming developed, North America is on its way to the opposite… This is a major concern to me and I’m surprised that not a lot of economists talk about it.

    Cheers,

    Flo.

  5. Pingback: 2010-’11: From Austerity to Collapse? « Reflections on a Revolution

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