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Are Italy and Spain on Fast Track to a Default?

by Brett on July 11, 2011

We’ve been watching the sovereign debt of Spain and Italy quite closely this year – and today, we saw the biggest fireworks yet.

Our friend and correspondent Dr. Evil had astutely tipped us off to the significance of the debt on the balance sheets of Spain and Italy.  While the world focused on Greece, these were the two elephants in the room to watch.

Yields on Spain and Italy 10-year bonds broke out decisively last week, as the mainstream financial press finally started to catch on to these stumbling giants as the real heart of the EU sovereign debt crisis.  And last week’s action now looks tame when compared with today!

Italy 10-year yields were up today – this is not a typo 41 basis points!

Will Italy Default in 2011 Bond Yield 10 Year

Italy yields go skyward. (Source: Bloomberg)

Meanwhile Spain “lagged”, up a mere 35 basis points:

Will Spain Default in 2011 Bond Yield 10 Year

Spain yields break out, too. (Source: Bloomberg)

The spreads between Spain/Italy debt, and German debt, reached yet another record since the EU formation in 1999.  Traders are rapidly dumping their Spain and Italy bonds for German bunds:

Germany 2011 Bond Yield 10 YearAs traders run for the safety of German bunds. (Source: Bloomberg)

Tough to blame traders – though it may be fair to ask: “What the heck took so long?”  Spain and Italy have massive sovereign debt loads, coupled with stagnant to shrinking economies…were a few extra points really enough to compensate for the significant default risk?

Italian shares have been taking quite the beating as well:

iShares MSCI Italy Index ETF price chartSource: StockCharts.com

The news headlines are filled with proposed plans and fixes.  Who knows if they can potentially save the day – count me skeptical.  Well me, and the bond marketas well.  And we all know better – I hope – than to argue with the bond market!


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