sPANISH DEBT FEARS & YIELD RISES SENDS INVESTORS SCUTTLING

Markets were in full sell-off mode today on Eurozone concerns although the Ibex did make sparkling recovery as the dat wore on even in the face of sharply rising Spanish debt yields as investors begin to anticipate the possibility of a full bailout for the country.

In the early part of last week optimism was the order of the day and equities managed to register gains even though the economic dataset was not encouraging but there is a growing risk-aversion sentiment that started on the lead in to last weekend with the German magazine Der Spiegel reporting that the IMF may not take part n any future loans conceded to Greece.

Contrary to what has been stated by many with vested interests, a Greek exit IS a cause for concern for the rest of the Eurozone, not because of the Greek assets held by other countries since almost all banks have now written off such assets but because investors start to think Italy and Spain will likely follow, particularly if it is a relatively orderly exit by the Greeks (which it probably will be).

Earlier in the morning, the Bank of Spain stated that he country had experienced a contraction of 0.4% in its GDP in the second quarter. Investors are looking at Spain and asking how a country approaching a 25% unemployment rate, with a troubled banking sector and indebted autonomous regions, where growth is not expected this year, can possibly overcome the crisis and repay any loans conceded by the troika. Bondholders are asking for 7.5650% remuneration on 10-year sovereign debt, a record high in the Euro era. The Spanish government is in trouble and the 7% yield that triggered full bailouts for other European countries has been largely surpassed now.

The German-Spanish 10-year spread has been rising steadily as investors trash sovereign debt from Spain & Italy too and seek for the safest German Bund. While investors punish Spain with higher yields, countries like UK, US, Germany, and France, experience ever-improving credit conditions. The UK government is now able to sell debt at a 300-year record low yield.

Bund v Spanish debt yield spread

The increase in risk-aversion led all the main equity indices to a blood bath although at the time of writing they are off the lows. The FTSE dropped more than 2% and is in better shape than many of its counterparts. The FTSE MIB was down almost 4% and the DAX 3%. US markets opened lower and the US Dollar has recovered from losses accumulated over the last few days. The recovery in the greenback is well depicted by the FXCM USD index that currently trades around 10,150 recovering from 10,025 observed last week. If bad news continues to be released, the index may threaten the early highs observed in May at 10,322.

Dollar index

Disregarding Eurozone problems and economic data has been an error. Equities may rise for a few days on improved earnings or monetary easing expectations but the unsolved problems in Europe continue to weigh very negatively on equities and will continue to boost sovereign debt yields and the safest currencies as the US Dollar.

Filipe R Costa