A few weeks ago I wrote a story asking if the chart of the Spanish 10 year government bond was the most important chart in the world today. I said:
“The European debt crisis continues to cause turmoil in the European economy and great uncertainty for the global economy. Investors are beginning to wonder if we’re on the verge of a Lehman 2.0 type event. Of course, if we’re due for a Lehman then we have to first serve up our Bear Stearns, right? And that’s exactly the fear here. The fear is not necessarily that Greece will default, but that Greece will lay the foundation for even larger defaults. And that’s where Spain comes in. Spain, in my opinion, would pose a bailout so large that it could very well become politically untenable. Greece and Ireland and Portugal are one thing, but Spain is twice the size of these three countries combined!”
Periphery bond yields are exploding higher today. And even more worrisome is the fact that this issue isn’t contained to Spain. If bond markets are any warning signal then it’s clear that the bond vigilantes in Italy are pushing the issue there as well. As I’ve mentioned in the past, Spain is the real bogey because the sheer size of this bailout will cause very serious political turmoil. If the Europeans have to consider bailing out Italy as well it would likely mean a more than doubling in the size of the bailout funds. Do the Germans and other core nations have that in them? I doubt it.
European leaders have failed to resolve this issue with a workable long-term solution. They appear oblivious as to the real root cause of their problems or simply unable to agree that they have only two options – full fiscal union or dissolution of some sort. And now the markets are deciding the outcome for them.
Buckle up. As I mentioned in April, the Euro crisis is still the single largest threat to global growth. And that means the risks in the region are beyond excessive. In the meantime, keep a close eye on these two charts. A breakout to new highs is not a reassuring sign and we’ve seen this movie play out in Greece and Ireland before. Without a workable solution, much higher bond yields in Italy and Spain should be expected in the coming quarters.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.