What we are all watching unfold right now is a complete and total
financial nightmare for Italy. Italian bond yields are soaring to
incredibly dangerous levels, and now the yield curve for Italian bonds
is turning upside down. So what does that mean? Normally, government
debt securities that have a longer maturity pay a higher interest rate. There is typically more risk when you hold a bond for an extended
period of time, so investors normally demand a higher return for holding
debt over longer time periods. But when investors feel as though a
major economic downturn or a substantial financial crisis is coming, the
yield on short-term bonds will often rise above the yield for long-term
bonds. This happened to Greece, to Ireland and to Portugal and all
three of them ended up needing bailouts. Now it is happening to Italy
and Spain may follow shortly, but the EU cannot afford to bail out
either of them. An inverted yield curve is a major red flag. Unfortunately, there does not seem to be much hope that there is going
to be a solution to this European debt crisis any time soon.
We are witnessing a crisis of confidence in the European financial
system. All over Europe bond yields went soaring today. When I
finished my article about the financial crisis in Italy on Tuesday night, the yield on 10 year Italian bonds was at 6.7
percent. I awoke today to learn that it had risen to 7.2 percent.
But even more importantly, the yield on 5 year Italian bonds is now
sitting at about 7.5 percent, and the yield on 2 year Italian bonds is
about 7.2 percent.
The yield curve for Italian bonds is in the process of turning upside down.
If you want to see a frightening chart, just look at this chart that shows what has happened to 2 year Italian bonds recently.
Do phrases like "heading straight up" and "going through the roof" come to mind?
This comes despite rampant Italian bond buying by the European Central Bank. CNBC is reporting that the European Central Bank was aggressively buying up 2 year Italian bonds and 10 year Italian bonds on Wednesday.