Eurocrisis worsens as Italian sovereign yields explode

Tom Tong14/Νοέ/2011Currency Updates

It was not a good week for the ECB’s struggle against financial and economic reality and as such the Euro had a rough week. As the central bank’s officials denied in increasingly stridently terms any intention to effectively support European sovereign financing, Italian and (to a lesser extent) Spanish yields blew out, pushing Italian yields above the 7% level, bringing the curve there closer to inversion amid thinning liquidity – roughly the conditions that necessitated a bailout for Greece, Portugal and Ireland. Ominously, French spreads are now where Italian spreads were six months ago. Later in the week, however, confirmation of Berlusconi’s resignation and his replacement by the technocratic Monti brought some relief; equities and currencies all ended the week more or less where they had begun.


The highlight of the week was the Bank of England meeting. As expected, there was no change in either the asset purchase target (GBP 275billion) or the rate (0.5%), and consequently there was no statement from the MPC. In the absence of significant news out of the UK, Sterling continues to trade as a low beta version of the Euro, and ended the week nearly unchanged against both the common currency and the dollar.


The round trip of Italian yields last week (up to 7.5% and back to 6.5% on the 10 year) should not be confused with stability. The enormous volatility is sapping both liquidity and long-term investor demand, not only for Italian debt, but for all non-German European debt. This includes the EFSF bailout facility, whose ability to leverage its resources seems to diminish by the day. Macroeconomic news is unlikely to provide any respite, either. Composite PMI confidence indicators are clearly in contractionary territory, and point to an outright contraction in the fourth quarter. Focus shifts now to Spain, where the almost certain change of Government after next Sunday’s general election is likely to provide more nasty surprises, if the incoming administration follows the usual practice of “kitchen-sinking” the problems as soon as possible and releasing all damaging information and data early in order to blame it on the outgoing Government.


The uptick in macroeconomic data out of the United States was tentatively confirmed by high frequency data last week. Weekly jobless claims finally dropped below the 400,000 mark, and Michigan consumer confidence came in somewhat higher than expected. We expect the dollar to continue behaving as a relative (by comparison) safe haven, given that the Swiss Franc and the Yen are being capped by their respective monetary authorities, and gold is trading more like a speculative asset than a refuge lately.


Written by Tom Tong

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