WOULD SPAIN GO DOWN ?
Fears that Spain will require a full-fledged sovereign bailout helped push Spanish government bond yields to another round of euro-era record highs Monday. On Monday, yields on benchmark 10-year bonds hit a record 7.57%, while 5-years reached 7.35% and 2-years were trading at 6.55%. The situation is looking increasingly unsustainable, with talk of an EU breakup on the table once again and speculation that Spain, and possibly Italy, will need a sovereign bailout to survive.
RISING BOND YIELDS SPELL TROUBLE?
Care is needed here for there is a time period where they signal trouble but are not yet a cause of it. This is because most government bonds have fixed coupons or interest-rates so they do not cost any more for the issuing government. Some bonds are influenced by market interest-rates but there are much fewer of them. Also index-linked bonds are influenced by inflation which may or may not be affected by this. So strictly speaking the problems for a country begin when the rise in its bond yields coincides with a period when it has to issue them. This is because issuing them is now on worse terms than before as they are more expensive in terms of the future interest that needs to be paid. European governemnts such as Spain, Italy, Greece and those of other peripheral nations are running fiscal deficits which are spiralling out of control. To fund these deficits the governments need to borrow money at exorbitant rates which signifies growing risk of default for an economy. Also some countries do not manage their debt well and have very short average maturities on it. This makes them more vulnerable to rising bond yields as they find themselves having to offer replacement debt more frequently and thus are more likely to be caught out by a period of higher bond yields.
ARE THEIR PARTICULAR LEVELS WHICH MATTER?
So far in the Euro zone crisis then a ten-year benchmark yield of 7% has proved to be a point of no return. However this is not a threshold for everyone as Italy has a lower threshold because of its high debt to economic output ratio (120%) and the fact she its has lot of bonds maturing in the next year (298 billion Euros). Another sign is when yields start rising quickly. Whilst on the day itself this may not matter as explained above it sets a bad precedent which in the nature of the two trading emotions of “fear and greed” tends to put fear on the front foot. Also rising yields on shorter-dated bonds matters and is another signal. Generally they start as being a fair bit lower than the ten-year benchmark and a sign of trouble is when they catch up as has happened in Italy over the past week. The situation where they heavily invert as in Greece spells simply crisis. Means that one year bond yield exceeds the ten-year and as it does so by some 195%, we can say that it has heavily inverted and is a sign of severe distress.
HOW DO HIGHER BOND YIELDS IMPACT ON THE WIDER ECONOMY?
Firstly they impact on their government which if it is spending more on its debt finds itself with less money to spend on other things. Or the government might wish to retain the status quo by raising taxes and cutting other spending to compensate. Countries such as Greece have found themselves in a vicious circle here where higher bond yields and an austerity programme have fed into each other meaning that austerity has ended up chasing its own tail. So in such an extreme case the underlying economy can be adversely affected quite severely. Other interest-rates such as fixed-rate mortgages and corporate borrowing are fixed in relation to bond yields so they tend to rise with them. thus by an indirect route the underlying economy has another contractionary influence on it. So not only are rising bond yields a sign of problems in an economy they contribute to future problems for it.
Fears that Spain will require a full-fledged sovereign bailout helped push Spanish government bond yields to another round of euro-era record highs Monday. On Monday, yields on benchmark 10-year bonds hit a record 7.57%, while 5-years reached 7.35% and 2-years were trading at 6.55%. The situation is looking increasingly unsustainable, with talk of an EU breakup on the table once again and speculation that Spain, and possibly Italy, will need a sovereign bailout to survive.
RISING BOND YIELDS SPELL TROUBLE?
Care is needed here for there is a time period where they signal trouble but are not yet a cause of it. This is because most government bonds have fixed coupons or interest-rates so they do not cost any more for the issuing government. Some bonds are influenced by market interest-rates but there are much fewer of them. Also index-linked bonds are influenced by inflation which may or may not be affected by this. So strictly speaking the problems for a country begin when the rise in its bond yields coincides with a period when it has to issue them. This is because issuing them is now on worse terms than before as they are more expensive in terms of the future interest that needs to be paid. European governemnts such as Spain, Italy, Greece and those of other peripheral nations are running fiscal deficits which are spiralling out of control. To fund these deficits the governments need to borrow money at exorbitant rates which signifies growing risk of default for an economy. Also some countries do not manage their debt well and have very short average maturities on it. This makes them more vulnerable to rising bond yields as they find themselves having to offer replacement debt more frequently and thus are more likely to be caught out by a period of higher bond yields.
ARE THEIR PARTICULAR LEVELS WHICH MATTER?
So far in the Euro zone crisis then a ten-year benchmark yield of 7% has proved to be a point of no return. However this is not a threshold for everyone as Italy has a lower threshold because of its high debt to economic output ratio (120%) and the fact she its has lot of bonds maturing in the next year (298 billion Euros). Another sign is when yields start rising quickly. Whilst on the day itself this may not matter as explained above it sets a bad precedent which in the nature of the two trading emotions of “fear and greed” tends to put fear on the front foot. Also rising yields on shorter-dated bonds matters and is another signal. Generally they start as being a fair bit lower than the ten-year benchmark and a sign of trouble is when they catch up as has happened in Italy over the past week. The situation where they heavily invert as in Greece spells simply crisis. Means that one year bond yield exceeds the ten-year and as it does so by some 195%, we can say that it has heavily inverted and is a sign of severe distress.
HOW DO HIGHER BOND YIELDS IMPACT ON THE WIDER ECONOMY?
Firstly they impact on their government which if it is spending more on its debt finds itself with less money to spend on other things. Or the government might wish to retain the status quo by raising taxes and cutting other spending to compensate. Countries such as Greece have found themselves in a vicious circle here where higher bond yields and an austerity programme have fed into each other meaning that austerity has ended up chasing its own tail. So in such an extreme case the underlying economy can be adversely affected quite severely. Other interest-rates such as fixed-rate mortgages and corporate borrowing are fixed in relation to bond yields so they tend to rise with them. thus by an indirect route the underlying economy has another contractionary influence on it. So not only are rising bond yields a sign of problems in an economy they contribute to future problems for it.
No comments:
Post a Comment