JUUGS Nov11.pngFinancial markets have become increasingly nervous in recent weeks, since the blog last reviewed developments in global bond markets.

Its conclusion then was that investors are worrying more about return of capital, than return on capital, as we transition to the New Normal. This is because 272 million westerners are now over 55 years old, and they need security of income as they prepare for retirement.

The chart above updates market moves in the JUUGS (Japan, UK, USA, Germany, Switzerland) and the PIIGS (Portugal, Ireland, Italy, Greece, Spain). Since August (blue column), the 2 groups have seen very different interest rate trends for 10-year government bonds (red line):

• Rates in the JUUGS have been extremely stable. UK and Swiss rates have edged down 0.1%, whilst German rates moved up 0.1%. US and Japanese rates are unchanged.
• The PIIGS have been much more volatile. Greece is now paying 34% vs 22% in August: Portugal’s rate is 12% vs 11%: Italy’s is 6.4% vs 5.7%: Spain’s is 5.5% vs 5.3%: only Ireland’s reduced, from 8.8% to 8.3%.

This suggests Portugal will also need to default on its debts, alongside Greece. Otherwise the burden of interest payments will simply become too large, particularly as austerity programmes lead to recession.

Italy, of course, is the real problem child. It is a rich and large G7 country. But its interest rate is now also close to being unaffordable. Two key questions are looming on the horizon:

• Will it really now allow the IMF to dictate its economic policy?
• What will happen to French and German banks if investors start to question Italy’s ability to repay its debt?

Italy currently owes $416bn to French banks, and $162bn to German banks. It owes a total of $788bn to European lenders. This is the concept of ‘contagion’:

• If Italy’s rates move into the 6.5%-7% area, and remain there, then its default becomes almost certain.
• France, another G7 member, would then be in the firing line.
• Its 3.3% interest rate is already 50%+ higher than those of the JUUGS. This suggests underlying nervousness amongst investors.

The blog will continue to monitor the situation closely.

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