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Nov 11

In Europe, something’s gotta give…

The spread between Italian bond and German bond yields hit a record today. Here’s what the chart looks for 10 year bonds:

Today’s Daily Reckoning dispatch writes:

Italy’s bonds have taken centre stage on financial markets. What’s at stake is whether Italy enters the feedback loop that ensnared Portugal, Ireland, and Greece. Once bond yields went past 6.4% in all those countries, they reached a kind of tipping point where investors lost confidence that those governments could ever repay their debts.

Ten-year Italian bond yields reached as high as 6.68% yesterday. That was 491 basis points higher than equivalent German debt. It’s not far below 7%, either. According to the Wall Street Journal it took Portugal’s yields 45 days to go from 6.5% to 7%. Irish yields did it in 34 days. Greek bonds did it in a day.

Bond traders call it “cliff risk“. A simple way to think about it is as a feedback loop, where rising bond yields lead to a collapse in confidence, which leads to more rising bond yields. The whole thing feeds on itself and accelerates. And in the government bond market, it appears to happen when 10-year yields go past 6.4%.

There are a few reasons for this. The simplest reason is that the interest paid on new government debt gets prohibitively higher beyond 6.4%. Government bonds are supposed to be “safe” because the government can always raise taxes to pay off bond holders. But a yield of 6.4% or beyond indicates the opposite: government bonds are not safe and may not pay off at all.

  9:32pm  •  Business & Finance  •   •  Tweet This  •  Add a comment

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