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  • European Debt Crisis Never Went Away

    Since December, the European Central Bank has loaned over 1 trillion euros to banks in southern Europe. These were three-year loans with an interest rate of only 1%. The banks used most of this money to buy up sovereign bonds of their home countries. This served to drive down bond yields around the region, and most observers assumed that the European debt crisis had been solved - at least for a while.

    Yet over the last few weeks, the unexpected has happened: bond rates in countries like Spain and Italy have started to rise again to dangerously high levels. Ten-year Spanish bond yields climbed to the highest level since the ECB started allocating three-year loans in December. Yields rose above 6% last Friday and yesterday, which sparked new concerns that Spain may need yet another ECB bailout. Making matters worse, Spain's economy slipped back into recession in the 1Q.

    Interest rates are also rising in Italy, and its economy appears to have dipped into a recession as well. All of this news has accelerated concerns that the financial crisis in Europe is back. Yet I argue today that the debt crisis never went away! Don't be surprised if this problem returns to center stage over the weeks just ahead, and if it does, this will not be good news for equity markets around the world.

    While US stocks are enjoying a very strong day today, there's a critical government bond auction in Spain on Thursday; Italy has a big bond auction on April 27; and Spain has another large bond auction on May 3. If interest rates continue to rise and/or if Spain and Italy have trouble finding enough buyers, this will be bad news. That's our topic for today.

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