Mike Spychalski, CAIA
This week’s Chart of the Week deals with the sovereign debt crisis in Europe. It is an update of a Chart of the Week from January, 2011 when yields on Portuguese bonds were trending towards 7% and there was much speculation in the market that Portugal was in need of a bailout package from the EU. Since then, Portugal received a bailout package from the EU and IMF and the fiscal situation in Italy has become the focus of attention in the markets. Over the past week or two there has been speculation that Italy will be the next country to require a bailout package. Yields on Italian government bonds have been steadily rising throughout the course of the past year, and in recent weeks the yield on the Italian 10-year bond has been trending towards 7%.
The 7% threshold is significant because Greece, Ireland, and Portugal were all forced to request a bailout package from the EU shortly after yields on their 10-year bonds exceeded 7% (based on a rolling 10-day average). The yield on Greek 10-year bonds broke through the 7% threshold on April 16, 2010, and Greece requested a bailout package on April 23, 2010. The yield on the Irish 10-year bond broke through the 7% threshold on November 15, 2010, and Ireland requested a bailout package on November 21, 2010. The yield on Portuguese 10-year bonds broke through the 7% threshold on January 31, 2011, and Portugal requested a bailout package on April 7, 2011. After the November 30 announcement of a coordinated action by six central banks to provide additional liquidity to financial institutions if necessary, yields on Italian 10-year bonds have backed away from the 7% threshold. Given that Italy has very little debt maturing in the final weeks of 2011, it is likely not in immediate need of a bailout package. However, Italy is still facing major fiscal issues over the near term. It has a high debt to GDP ratio (118% as of 12/31/10), a high unemployment rate (8.2% as of 9/30/11), and a low growth rate (0.8% as of 6/30/11). In addition, Italy has over €320 billion in debt maturing in 2012, and unless the market perceives a material improvement in Italy’s fiscal situation, it will be difficult for the yield on its 10-year bonds to stay below the 7% threshold.
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