04.16.2012

Sovereign Yields Rise

04.16.2012

Spain is back in the spotlight along with other darlings of the Eurozone including Portugal, Italy and even France. Credit risk is becoming a huge issue as investors are beginning to realize there are two inherent problems associated with Europe.

The first issue at hand is that of liquidity and buyback programs via the European Central Bank and European Financial Stability Fund (EFSF). Currently, more than 1 trillion euros have been thrown at the sovereign debt situation in Europe. The pools of liquidity offered by the ECB have soothed market participants for around a month to a month-and-a-half on average before concerns flare up again.

Institutional investors in the credit space are now questioning how much longer a Band-Aid can keep being placed over the wounds in the EU before a new one is needed. Surprisingly, despite a sharp drop in the price of 10-year Spanish and Portuguese bonds on Monday, stocks in the U.S. rallied. But the issue of continuous bailouts leads to the second with Europe: reform.

Fiscal reform and austerity are already difficult things to implement into society in places like Greece and Italy. Acting on those reforms has proven nearly impossible. The issues of proper taxation (and collecting said taxes), cutting pensions, and raising the age of retirement have been met with riots and protest from citizens of some of the aforementioned countries. This does not bode well for credit investors who are long the debt of these nations.

So what is the solution to these two problems and the Eurozone crisis as a whole? Default. The longer the can is kicked down the road, the more it will hurt investors and governments in the long-term while only providing short-term relief according to some.

“These countries are doing themselves more harm than good by prolonging this problem with their debt,” said one credit trader on the institutional side. “Basically, the EU needs to be broken up, these guys need to own up to their debt and stop procrastinating and really, all of this should have happened five or ten years ago.”

The outcome of the Eurozone crisis is still incredibly opaque. As of Monday afternoon, Portugual’s 10-year bond was trading with a 12.36% yield and Italy’s 10-year at 5.58%. Both are heading higher and are shaping up to soon hit a level on par with Greece’s whopping 20%+ yield.

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