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Portuguese 10 year yields continued their ascent this morning as bond vigilantes in Europe continue to force the issue.  Although it’s clear that the ECB will be a continuing buyer of bonds it is looking increasingly likely that Portugal will eventually need aid.  At that point the market will clearly turn their focus on Spain.  A bailout of Spain (should bond markets force it) would require substantial alterations to the current bailout mechanism and likely cause further market jitters.  On the whole, none of this looks catastrophic or remotely similar to Lehman 2.0 at the moment.  The simple reason is that the ECB and Bundesbank have made it clear that they will protect the Euro at any cost.

The bigger risk to the region, in my opinion, is the effects of austerity and the eventual realization that austerity is not helping to resolve the recessions and depressions on the periphery. The divide between the core and periphery is likely to persist and grow. Continued hardship has the very real risk of forcing dramatic political shifts, social unrest and eventually the potential for defections/defaults.  For now the problems appear contained, but it’s still difficult to imagine this situation resolving itself as the current bailout mechanisms are arranged.  Eventually, real reforms will be needed if the Euro is ever going to work.

(Portugal 10 year yield via Bloomberg)

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