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Euro zone storm continues to build [ClearOnMoney]
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Euro zone storm continues to build

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Commentary

Euro zone storm continues to build

25 Nov 2011 by Jim Fickett.

Most European bond yields have gone significantly higher in the last few days. All eyes are on Italy, of course, and Italian yields are setting new highs:

A peak of 8.13 per cent was reached on three-year bonds, according to Reuters data, as Italian debt traded deeper into territory associated with bail-outs of Greece, Portugal and Ireland in the past 18 months.

Italy raised its targeted €10bn in an auction of two-year bonds and six-month bills but at sharply higher yields.

“Rates have skyrocketed. It’s simply not sustainable in the long run,” said Marc Ostwald, strategist at Monument Securities in London.

Investors demanded a yield of 7.81 per cent for the two-year bond, up from 4.63 per cent last month. The six-month bills saw yields of 6.50 per cent, up from 3.54 per cent. That was significantly higher than Greece paid for six-month money earlier this month when it issued bills at 4.89 per cent.

That means both Rome and Madrid have paid more than Athens for short-term debt this week.

Padhraic Garvey, interest rate strategist at ING in Amsterdam, said: “It’s not great, to be honest, not in good shape at all … The pricing is awful.”

Sovereign debt is of course the fundamental problem, but the practical consequences of the crisis will come first through the banks. Confidence in banks seems to be falling rapidly:

“It is an absolute disaster zone. I wouldn’t touch [bank stocks]. You couldn’t make me buy a bank,” says Paul Casson, director of pan-European equities at Henderson Global Equities.

Even some bank chief executives seem to agree. “I’d be very interested to see the investor who is prepared to put more capital towards UK banks. All of them are thinking that’s a dumb place to put capital,” Stephen Hester, chief executive of RBS, the part-nationalised UK lender, said this week.

A toxic combination of high exposure to distressed eurozone government debt, funding worries and an ever-likelier impending recession is knocking bank shares heavily. Eurozone banks as a whole have fallen by more than half since peaking in February, and have only been lower since the start of the 2007-08 financial crisis for a few days in March 2009.

How should one react to all this? Overall, equity market values, despite having fallen considerably, are looking optimistic relative to bond markets. My base case is a significant further fall in equities. However I'm not willing to go short in this market because the outcome depends on the whims of politicians. The best thing to do is probably to focus on bargain hunting as the crisis progresses.