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Europe's Credibility Gap

Spanish (and other) bond yields whipsawed back and forth, money poured in and out of safe-haven assets, and the U.S. stock market gyrated back and forth. The forces behind these moves are nothing new. The market's fear gauge continues to move up and down based on an assessment of how willing and able European institutions are to stem the crisis.

Jeremy Glaser 13.08.2012


Spanish (and other) bond yields whipsawed back and forth, money poured in and out of safe-haven assets, and the U.S. stock market gyrated back and forth. The forces behind these moves are nothing new. The market's fear gauge continues to move up and down based on an assessment of how willing and able European institutions are to stem the crisis. Until these institutions are able to convince the markets, once and for all, that they have the crisis under control, the volatility isn't likely to stop.

The gauge was sky-high earlier in the week as Spain remained in laser focus. Continued issues in regional governments, a huge number of unanswered questions about the pending bank bailout, and concerns about a further slowing economy sent 10-year bond yields over the 7% level. And it wasn't just long-term debt that was getting hammered; short-dated bonds took a beating, too. As Morningstar's corporate bond strategist Dave Sekera pointed out, the hefty yield on the two-year bonds indicated the market was beginning to believe that a near-term default was becoming more likely. With high short- and long-term borrowing costs, Spain could find itself in a situation where it becomes very difficult to refinance debt that is coming due. This would exacerbate the country's financial situation and send rates even higher.

With the fear of higher rates in mind, European Central Bank head Mario Draghi waded into the market on July 26th to say that the ECB was ready to do what it needed to in order to keep the euro together. Draghi promised that the central bank has the firepower to keep the situation under control. Add in some supportive comments from German chancellor Angela Merkel and French president Francois Hollande, and the talk was enough to send markets higher and bring Spanish debt off the edge. Investors are hoping that this talk turns into an ECB-led sovereign bond-buying program that will keep borrowing costs at reasonable levels as peripheral countries make the fundamental reforms needed to get their economies back on track.

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About Author

Jeremy Glaser  Jeremy Glaser is the Markets Editor for Morningstar.com.

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