So what’s really behind the spike in Spanish government bond yields on Monday?
How about this: because of Angela Merkel’s European Stability Mechanism the market is finally being being forced to price in default risk for eurozone countries.
Simple eh?
Harvinder Singh of RBS thinks so.
Introducing the Merkel crash: (Emphasis ours.)
We expected a relief rally – even if the only relatively safe place was seen as the short end of rescued countries such as Ireland – but in the event the market has moved very quickly to the title of the research note: European periphery crisis: no turning point in sight yet.
The spread widening after the initial tightening should frighten policymakers. Make no mistake this is a crisis of EMU. The market assessment is that the new policy structures, now with a relatively trivial watering down of the private sector restructuring risk, makes little sense.
The market is correct. This is the Merkel crash we have been outlining. If you think a country will get a high coupon for new issuance in H2-13 then it is right to see the sovereign weaker right now. Then the self-fulfilling nature of the crisis starts. For example, SPGB 10y is at 5.4% now from 4% in October. That makes the legwork much harder for Spain. We see 10y spreads at 300bp this week and then the market will test 450bp where the repo haircuts kick-in. Italy is expected to get dragged out with Spain and there should be new highs in spreads in core EMU too. We expect some flight to quality to Bunds but the fact that even German debt trades poorly reflects the fact that one way or another Germany will end up paying more. The only hiding place in Treasuries and to a lesser extent Gilts.
So is this the end of EMU? No – but the key point is that the problems need to hit Germany before more viable solutions such as more fiscal and political integration look likely. That is, it may take a near death experience for the periphery and core EMU banking systems before this realisation dawns. At that juncture, it is possible to see some form of quasi fiscal union via a common EMU bond.
Hang on your tin hat.
Related link:
Ireland rescue fails to stem debt fears – FT
The reflexivity of Irish bonds – FT Alphaville