“Contagion has spread across eurozone bond markets like wildfire,” said Crédit Agricole. This week, the debt crisis spread from the periphery to the core. Yields on Spanish and Italian debt surged again as their bonds were sold off, with the latter’s ten-year bond yield back over an unsustainable 7%. That’s well above levels that saw Portugal, Ireland and Greece frozen out of the debt markets and needing a bail-out to avert a default.
But French and Austrian yields also jumped. Their ten-year spread over German paper, a measure of how risky they are perceived to be, jumped to euro-era highs. Belgian and Dutch yields also rose. Technocratic governments in Italy and Greece gradually took shape following the recent departure of their prime ministers. The latest macroeconomic data for the eurozone were poor. Industrial output fell by the most in two years in September.
What the commentators said
Tough new capital targets for banks were a key reason for this week’s mass sell-off, said FxPro.com. As raising capital in the markets is virtually impossible at present, banks have chosen to meet the targets by ditching assets. Italian and Spanish debt is being offloaded first, followed by bonds considered vulnerable owing to their exposure to Italy and Spain – French and Austrian ones, primarily. What’s more, “money managers are being sucked into the same vortex”, rushing to ditch debt, as they know that banks are big sellers.
The crisis also worsened this week because “the risks of another sharp recession [in the eurozone] are growing rapidly”, said Capital Economics. The credit squeeze in the interbank market caused by worries over sovereign debt exposure is hampering lending. There has been a decline in business confidence amid the debt crisis and austerity programmes in large eurozone economies have also crimped growth. Without growth, there is no chance of indebted economies getting their borrowings under control.
Investors also know that “changing the players at the top of Italian politics was the easy bit”, said Nils Pratley in The Guardian. All the structural reforms required to juice growth, and thus start tackling Italy’s huge debt pile, will take a long time to work. There is ample scope for political and social unrest due to the reforms and tighter fiscal policy. “The chances that this is going to work smoothly are not high,” said the FT’s Martin Wolf.
Italy is also too big for the eurozone rescue fund to bail-out. The European Central Bank, thanks to German resistance, is loath to fire a silver bullet by printing money and buying up peripheral bonds on a major scale. That would slash interest rates on bonds and banish fears of a default.
Without this firewall, it’s hard to see how “the cycle of austerity, economic contraction, contagion, and financial retrenchment can be broken”, said Economist.com. In the meantime, the risks of a messy default and financial crisis are rising. “The eurozone is in a death spiral.”