Italian 10-year yields are now down below 6.5%, that’s a full percentage point lower than on Wednesday. Market players suspect ECB intervention is behind the sizable move. Still, everyone is breathing a sigh of relief as we head into the weekend.
Nevertheless, problems remain. You may have seen the story on contagion’s spread to Slovenia. Their bond yields have reached a record high of 535 basis points. And they too must now pay 7% for 10-year money. I wrote in June that many felt that Slovenia had become the new problem child of the EU. As the first Eastern European country to join the euro zone in 2007, they were seen as a sign of the success of the European experiment. This has gone somewhat off the rails and now they are the next victim in the ever-widening euro zone death spiral.
Here’s what I hear some traders in Europe a friend recently spoke to believe. They expect the ECB or an ECB-funded EFSF to become the buyer of last resort of all euro-denominated government bonds, and to eliminate the spreads. The question is when. They say the worst case scenario is that the ECB moves only when a full-fledged bank run is about to begin. The best case scenario is that they move when ECB-approved PMs rule both Greece and Italy.
They also see that the quid pro quo will mean an inevitable reduction of sovereignty, but they understand that austerity alone will lead to disaster. There is a (small) signal of increased support for a change in European rules is possible to allow this. But these traders say that more likely Draghi will preside over the collapse of the currency which he is tasked to manage for the next 8 years.
That’s close to a verbatim report I got from Italy. Thanks for the update, Andrea. This is all very much in line with what I have been telling you for one year now. And I still think it will happen this way. But clearly the risk to asset prices is all to the downside and that means risk off.