Anatomy of a Credit Contagion

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–The gold charts we showed you yesterday made the case for a golden recovery. Today we cede the chart analysis to the master, our technical guru Murray Dawes. Murray’s posted his latest big picture update over at his Slipstream Trader YouTube channel. Go have a look now.

— Murray’s work highlights the interconnection of markets. But you have to wonder if the equity markets have basically put up their hand to the bond market and said, “Talk to the hand, baby.” That’s what you do when someone has bad news you’d rather not hear, baby.

–What bad news? How about one-year Greek bond yields of 114%? This is the bond market’s way of telling you Greece is going to default. In fact, that news is probably old news for stock market investors. So what’s the new news?

–The new news – the news not priced into the stock market yet – is that the €3 trillion figure being thrown around in markets might as well be a basket of unicorns, shamrocks, and rainbows. If investors think the European Financial Stability Facility (EFSF) is the €3 trillion solution to Europe’s sovereign debt woes, they are bunch of suckers and deserve the losses that are coming.

–Moral judgements aside, the bond market is starting to communicate some useful information about Italy and Spain. Mind you, the European Central Bank has been doing the equivalent of putting its hand over the bond market’s mouth and telling it to shut up. By buying government bonds, the ECB keeps official borrowing costs down for Spain and Italy and confuses the price signals coming out the market.

–But the signals are still there. Yesterday Italy and Spain sold a combined $24 billion in bonds. Most of them were short term. The market is reluctant to lend to European governments for 30 years. But three months is doable.

–The yields on Italian and Spanish bonds are still remarkably low given the size of the debt that needs to be refinanced in the next 12 months. Italy paid 4.51% at its auction of two-year notes. The interest rate on 10-year Spanish government bonds is now 5.07%

–You can see from the chart below that Italian and Spanish 10-year yields have not yet gone the way of Greece, Ireland, and Portugal. If and when they do, all hell will break loose in financial markets. The ECB is trying desperately to prevent all hell from breaking loose.

10 year government bond yield

–As for shares, the best thing you can say about them right now is that they’re not European government bonds. That alone may have accounted for the big moves overnight. Aussie stocks rocketed up 3.6% by the close yesterday. Gold, silver, and commodities rallied too.

–But it’s probably not a bad time to back up, grab a history book off the shelf, and see if anything like this has happened before. You’ll find a case study from Greg Canavan, editor of Sound Money. Sound investments. The excerpt is taken from a recent issue of his monthly report. It’s the anatomy of a credit contagion…

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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4 Comments on "Anatomy of a Credit Contagion"

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Alexander Malejew
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Dan, no matter how logical your argument (and it is flawless, in my view!) the people who make decisions have a certain idiotic faith in their abilities to save the EU.
They are more stubborn than mules.

shortchanged
Guest
An interesting history lesson Dan, but as what is happening now has happened before, you have to ask, why?. Are the banksters so consumed with utter greed and corruption that they try it on every generation or so. It seems to a layman (myself) that there is a, wait for it, conspiracy. What else could it be, and it is against us the general PAYE taxpayers, (actually i am retired) whom have no knowledge of what is going on and can do nothing about it?. Every one want’s to be independent and financially secure, but this mega greed is something… Read more »
Ross
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Other are starting to get the germ Fisher, it is high time that DR did too.
http://www.bloomberg.com/news/2011-09-27/fisher-says-central-bank-is-under-attack-from-ron-paul-barney-frank.html

Joe
Guest
Alan Kohler on the ABC 7pm news last night described the new (restarted) talks between the IMF/ECB and Greek Government with the phrase ‘With Greece bringing out the other, other, books’. It is a deceiptful government which has lied its way into its current predicament. What political will is there in the voting class of Germany to help them out. I would argue none. You made your bed, you lie in it, is the common viewpoint shared around the World, and particularly in Germany. The German Government will be like Turkeys voting for Christmas if they allow the German nation… Read more »
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