The European debt crisis is rolling across the continent at alarming speed, proving that almost no country is immune to the contagion unleashed by Greece and Italy as confidence in the region's ability to reduce its debt loads evaporates.
Yields on the 10-year bonds of France, Belgium, Spain and Austria all soared to record euro zone highs on Tuesday in spite of fresh data showing that the German economy is still expanding and despite the tentative launch of caretaker governments in Rome and Athens with mandates for economic reform.
The mass selloff drove up the debt yields of countries that had been considered havens, including Finland and the Netherlands. "Global financial markets are facing a key pivotal point," analysts at Barclays Capital said in a Tuesday research note. "A further escalation of the European debt crisis is putting at risk the nascent stabilization of global growth."
Italy's post-Silvio Berlusconi honeymoon proved exceedingly short-lived. Last week, yields on 10-year Italian bonds went to a record 7.48 per cent. They dipped after Mr. Berlusconi resigned as prime minister, then came roaring back, climbing back above 7 per cent on Tuesday, even as Mario Monti, his replacement, came close to forming a new, cross-party government. Mr. Monti is to unveil his cabinet on Wednesday in Rome.
The bond selloff hit France, whose triple-A credit rating is at risk. The French bond spread over equivalent German bonds widened by 23 basis points to 188 basis points, the most since the common currency was launched in 1999 (100 basis points equals one percentage point).
The yield on German debt – the euro zone's last low-yield sanctuary – continues to sink as investors rush to safety. At 1.76 per cent, the yield on 10-year German bonds is now less than half of the French yield.
Spain, where the economy is on the verge of another recession and unemployment is still rising – it reached a new euro zone high of 22.6 per cent in September – saw its 10-year bond yields surge to 6.3 per cent. That took the spread over German bonds to a record 458 basis points.
The resurgence of Spain's debt crisis was underlined by the treasury's failure on Tuesday to reach the target sale of €3.5-billion ($4.8-billion) of 12- and 18-month bills. The yield on the 12-month securities went to 5 per cent, well above the 3.6 per cent at a similar sale only a month ago.
The rising bond yields throughout the euro zone, outside Germany, can in good part be blamed on the banks' wholesale retreat from sovereign debt. The banks are under political pressure to keep their Greek bonds, for fear that a wave of selling would destroy what little remains of the country's debt market. That means the banks are unloading other risky sovereign bonds, in particular Italy's, to bring down their overall exposure.
BNP Paribas, one of the largest French banks, reduced its Italian bond holdings to €12.2-billion from €20.8-billion in the third quarter. Deutsche Bank reduced its Italian exposure by 88 per cent in the first six months of the year. Germany's Commerzbank AG said earlier this month that it is selling sovereign bonds at a loss, and Global Sovereign Open, Japan's biggest mutual fund, unloaded all of its Italian bonds this month, according to a Bloomberg News report.
Economists think the rush to sell sovereign bonds was triggered by several factors: a European Union agreement with the banks to write down Greek bonds by 50 per cent, creating a precedent that bond investors fear will be repeated elsewhere in the euro zone; the European Central Bank's reluctance to buy distressed bonds; and European politicians open talk about member countries leaving the euro zone.
On Tuesday, Dutch Prime Minister Mark Rutte said it should be possible to expel members from the euro zone. The day before, German Chancellor Angela Merkel's Christian Democratic Union party voted to allow countries to leave the euro zone. While the vote carries no legal weight, it reflects the CDU's rising skepticism about the euro project.
The near certainty that the euro zone is about to enter another recession also spooked the bond markets.
Eurostat, the European Union's statistics agency, reported Tuesday that the euro zone's gross domestic product expanded by a mere 0.2 per cent in the third quarter over the previous three months. While Germany performed well (with third-quarter growth of 0.5 per cent) economists warned that 0.2 per cent was probably as good as it gets and that the next figure might be negative because of the escalating debt crisis and austerity programs.