Wednesday, November 16, 2011

EU Bond Markets Drop

From the WSJ:

Europe's debt troubles on Tuesday spilled over to top-rated nations that had been largely untouched by the crisis—including Austria, the Netherlands, Finland and France—in an ominous sign for European policy makers.

Bond yields across the Continent jumped as prices dropped, in a sign of investors' faltering confidence in officials' ability to keep the debt crisis contained in the euro zone's troubled peripheral countries. Tuesday's selloff came amid news that the euro zone's economy scarcely grew in the third quarter.

Trading of anything but German bunds—seen as safe securities akin to U.S. Treasurys—became difficult. Investors sold bonds issued by triple-A rated France and Austria. Even prices of bonds issued by fiscally upright Northern European triple-A nations such as Finland and the Netherlands fell. Among the cash-strapped periphery, Italian bonds again rose above 7% and Spanish yields surged to 6.358%, according to Tradeweb.

The EU crisis is now spreading.  This will do a few things -- none of which are good.

1.) It greatly increases the possibility of an EU recession in the next 12-18 months.  This is a financial shock that will greatly hurt a financial system that doesn't need a shock of this magnitude at this time.

2.) It places a tremendous amount of negative pressure on the EU.  As the crisis has progressed, there have been calls/predictions that this will be the end of the EU.  I have not been one of those, as I believe the EU has a strong desire to remain together.  But, the degree with which the contagion is spreading cannot be ignored, and it greatly challenges the financial workings of the continent.  That leads to the question of "will we see a partial break-up?" which would be just as bad -- and probably just as messy

3.) The increases possibility this will be an economic drag on the US -- just as it appears we might actually be getting some economic escape velocity working.

4.) It increases the stress on the international financial system.  In the latest senior loan survey, US banks reported increasing lending standards to banks with EU exposure.  3-month libor and has been climbing steadily since the beginning of August, indicating financial stress is increasing.  

In short, this is a bad development -- at a time when we really don't need this type of thing to happen.