Mike Shedlock

In response to EU Calls Emergency Meeting on Italy; Don't Worry "It's a Coordination, Not a Crisis"; Short Sellers Blamed; Junckeritis Spreads I received an interesting comment from "fedwatcher"

The “Bond Vigilantes” are out in force in the European Sovereign Debt markets. What is at risk here is not Italy, rather it is the Euro itself.

The Euro-zone suffers from an incomplete financial system. The collection of sovereign states that adopted the Euro have toothless central banks that in turn depend on a toothless ECB. The ECB is not a central bank equivalent to the U.S. Federal Reserve or the Bank of England as there is no European Treasury and no central taxing authority. Rather the Euro-zone states depend on the support of individual banks and those banks are all over levered with too much sovereign debt.

The assumption was that these banks did not have to have reserves against sovereign debt as there was no default risk. As the real problem of default was recognized, these banks bought Credit Default Swap insurance but the “insurers” cannot pay off.

The PIIGS have the power to bring the Euro down. That is their hole card. The German public has the power to bring the Euro down. That is Berlin’s hole card. The French have no hole card and across the border in Belgium you have a sovereign state largely dependent on its hosting of many EU bureaucrats.

Many European banks are on life-support from the U.S. Federal Reserve since the EU is toothless. Thus, the U.S. is a hidden party to these negotiations.

So in the Euro-zone we have insolvent banks, insolvent governments, and a currency union that lacks the full set of tools to survive. No wonder the Bond Vigilantes are out in full force.
Portugal 2-Year Government Debt Yield



Portugal 10-Year Government Debt Yield



Italy 2-Year Government Debt Yield



Italy 10-Year Government Debt Yield



Spain 2-Year Government Debt Yield



Spain 10-Year Government Debt Yield



Ireland 2-Year Government Debt Yield



Ireland 10-Year Government Debt Yield



Greece 2-Year Government Debt Yield



Greece 10-Year Government Debt Yield



Germany 2-Year Government Debt Yield


Germany 10-Year Government Debt Yield



ECB president Jean-Claude Trichet has been battling Germany, the bond markets, and EU officials over his "No Greek default, not even a soft one" stance. That battle is about ready to come to an inglorious end for Trichet.

The Financial Times reports 
EU stance shifts on Greece default

European leaders are for the first time prepared to accept that Athens should default on some of its bonds as part of a new bail-out plan for Greece that would put the country’s overall debt levels on a sustainable footing.

The new strategy, to be discussed at a Brussels meeting of eurozone finance ministers on Monday, could also include new concessions by Greece’s European lenders to reduce Athens’ debt, such as further lowering interest rates on bail-out loans and a broad-based bond buyback programme. It also marks the possible abandonment of a French-backed plan for banks to roll-over their Greek debt.

“The basic goal is to reduce the debt burden of Greece both through actions of the private sector and the public sector,” said one senior European official involved in negotiations.

Officials cautioned the new tack was still in the early stages, and final details were not expected until late summer. But if the strategy were agreed, it would mark a significant shift in the 18-month struggle to contain the eurozone debt crisis.

Until now, European leaders have been reluctant to back any plan categorised as a default for fear it could lead to a flight by investors from all bonds issued by peripheral eurozone countries – including Italy and Spain, the eurozone’s third and fourth largest economies.

A German-led group of creditor countries has for weeks been attempting to get “voluntary” help from private bondholders to delay repayment of Greek bonds, a move they hoped would lower Greece’s overall debt while avoiding a default.

But in recent days, debt rating agencies warned any attempt to get bondholders to participate would represent a selective default. Rather than abandon bondholder buy-ins, however, several European leaders have decided to return to a German-backed plan to push current Greek debt holders to swap their holdings for new, longer-maturing bonds.

The move essentially scraps a French proposal unveiled last month, which many analysts believed would only add to Greek debt levels by offering expensive incentives for banks that hold Greek debt to roll over their maturing bonds.

Officials said the Institute of International Finance, the group representing large banks holding Greek debt, has gradually moved away from the French plan and begun to embrace elements of the German plan.
At long last Trichet is about to find out he is not bigger than the bond market.

Help for Italy?

Bloomberg reports 
Euro Falls to Two-Week Low as Leaders to Meet Amid Contagion Concerns
The euro dropped against most major peers after Die Welt reported that the European Central Bank is seeking to expand a fund to include help for Italy, following a coordinated rescue for Greece by the European Union and International Monetary Fund.

“Italy is a very large economy, and if indeed we do see contagion spread toward Italy, then the ECB, EU and IMF will need to come up with a totally different plan to deal with it,” said Khoon Goh, head of market economics and strategy at ANZ National Bank Ltd. in Wellington. “Ongoing sovereign concerns are proving to be a real drag on the euro.”

The yield on Italy’s 10-year bond rose to a nine-year high of 5.27 percent on July 8, driving the premium over German bunds to a euro-era record of 244 basis points.

The bailout fund may have to be doubled to 1.5 trillion euros ($2.13 trillion) to cover a crisis in Italy, the ECB said, according to the German newspaper Die Welt. The Financial Times cited unidentified senior officials as saying European leaders are prepared to accept that Greece should default on some of its bonds.
Invisible Elephant Now Visible

On January 7 I posted 
Italy The Invisible Elephant.

Six months later, mainstream media is discovering that fact.

I had to laugh when three days ago 
Calculated Risk commented A top European analyst put out a research note last night calling Italy "the elephant in the room".

Italy is now clearly visible, and mainstream media is 6 months late.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Mike Shedlock

Mike Shedlock is a registered investment advisor representative for Sitka Pacific Capital Management.