Saturday, July 7, 2012

Steepening periphery curves combine need for yield with increasing sovereign risks

As discussed in the previous post the ECB's move to set the deposit rate to zero has pushed the short end (2 years and under) of the German curve into negative yield territory.

Desperate to earn non-zero yield on their cash, some investors have decided that Italy is not going broke in the next few months and bought short term Italian paper. In that sense the ECB accomplished its goal of pushing investors into riskier assets, but only at the short end of the curve. Because at the same time the realization that the EU summit euphoria was premature has pushed the longer term yields higher, negating the ECB policy action.

The situation was far worse with Spain as only the 3-month bills benefited from negative German yields - with Spain's 3m yield falling below 2%. Yields on the longer maturities increased substantially, as the 10-year note is once again pushing toward 7%.

So this is the extent of the ECB's success in the recent policy action. Other than rolling very short maturities at lower rates, Eurozone periphery government financing is becoming increasingly more expensive.
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