• Financial system contagion continues to spread and slowly spiral out of control. Interest rates demanded by bond buyers, and implied interest rates from credit default swaps (CDSs) are higher across the board. It doesn’t matter whether you’re a PIIGS country, BIGPIGS country, or anywhere else in the Eurozone.  The Brits must be downright gleeful they have access to cheaper money than Germany does –all entirely because they can print their way to prosperity. Consider how perverse that is. The Brits can print their own currency thereby destroying its value — and in parallel lowering the value of their bonds. Yet this is the reason British gilts are trading favorable to German bunds.  That, plus the likelihood that Germany will be forced to bail out the eurozone. (This is a silly notion. A country of 80M people with poor demographics can’t bail out a combined population of 320M.)
  • Europe’s stock markets have been driven higher whenever a summit is held – or even merely announced. Last week saw a mini-summit with Merkel, Sarkozy, and Monti. Merkel held her ground in repeating Germany will not agree to joint eurobonds. That took the air out of stock markets. But the rumor mill persists. Apparently Germany and France are planning a quickie treaty. Rather than try to ammend the existing eurozone trade treaty (would take years), they’re considering a new treaty that might be in place for January 1 2012. There are whispers that if so, the ECB might step-in and buy everyone’s bonds in mass, print euros, and stop the melt-down. How this fails to violate existing treaties and constitutions is beyond me.
  • In another attempt to defy reality yet again, Friday morning saw news that European regulators may drop their plan to force bond holders to accept losses (volunteer) on their bonds prior to the 2013 permanent bailout fund (the  ESM). This spurred a mini-rally in risky assets (stocks). This is silly. There’s no chance the AAA rated European countries will agree to this. France being the exception — which is going to lose its AAA rating soon. 


    S&P lowered Belgium’s sovereign debt rating on Friday. Yields on 10-year bonds are approaching 6%. Belgium will soon be infecting the ECB’s balance sheet — the ECB will have to begin buying Belgian bonds in order to suppress the interest rate.


     Arguably the biggest economic news last week was the failed German bund auction. This was the weakest auction since the inception of the euro. Mind you, the interest rate on offer was an historically low 1.98% for 10-year bunds. So perhaps investors were balking at an unattractive interest rate from a German Treasury that overplayed its hand.  A failed bond auction associated with the lowest interest rate ever offered is entirely different from a failed bond auction with the highest interest rates offered. Plus, investors are scooping up short term German sovereign bonds with such demand the yield has been driven negative. That means investors are willing to accept a guaranteed loss on their money to have it in short term bunds.


    Fitch bond ratings agency lowered Portugal’s sovereign debt rating to junk. This was no surprise. Portugal has been dragging their feet with implementing the agreed reforms (in return for the 100B+ euro bailout). Like all of southern Europe, Portugal needs to drastically lower wages in order to become competitive. Doing do will cause a depression.  Implied interest rates based on the trading of 10-year Portuguese bonds rose to 12% levels. Good thing they’re not reliant on raising cash from the bond market and have a bailout fund to rely on.


    Friday saw a weak 2-year Tnote auction that drove the yield on the 2-year note up to 8% — another euro-era high . Tuesday saw record high yields on the 3-year and 10-year notes due to weak auction demand. With the 10-year yielding 7.5%+, Italy is now firmly in the bailout zone (other PIIGS countries were strong-armed into accepting a bailout when their interest rate on the 10-year got this high).  And again I point out this is with the support of the ECB buying bonds in the background to help keep a lid on it. Absent the ECB, this game would have been over long ago.   This situation will not last. Something has to give.