Tags: barry | elias | European | Yield | Inversion

European March Toward Yield Inversion Began in March

By Barry Elias   |   Friday, 15 Jul 2011 07:06 AM

Government bond yields across the globe are inverting.

Three weeks ago, I described this occurrence in China.  

The European march toward yield inversion began in March.
And it is continues.

The bond yield curve inverts when short term yields exceed long term yields.

Typically, the reverse occurs, since long-term investments are associated with more risk. Long term risk, such as price inflation, currency depreciation, default, and lost opportunities, require higher rates of return to attract the appropriate quantities of capital investment.

However, when the yield curve inverts, short term investments pose greater risk, which requires higher yields to attract capital. This additional risk reflects anticipated uncertainties and reduced economic growth, near term.

The following graph depicts the inverted bond yield spread (in bold) between the 2-year and 10-year government bonds for several European nations, as well as the inception date for the inversion.


Germany, Spain, and Italy currently do not have inverted bond yields.

However, in recent days, upward pressure on Italian yields has been intense due to its fiscal uncertainties. During the past decade, average annual economic growth in Italy was 0.2 percent, versus 1.1 percent for the entire Eurozone (roughly 80 percent less).

In addition, Italian public government debt as a percentage of Gross Domestic Product is 120 percent, double that of the US (this figure does not include intragovernmental debt, such as social security trust funds).

During the past week, the yield spread between the 10-year government bonds of Italy (higher) and Germany (lower) increased 1 percentage point to 2.85 percent, a 55 percent increase. Germany is the only European country where interest rates, short and long term, are low and falling.

The European march toward yield inversion continues, with Italy and Portugal as possible entrants.

A current contagion of global yield inversion portends slower economic growth world-wide.

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