How Ugly Did Europe Just Get?

Global financial markets got beat down, Monday, on what was effectively a repricing of sovereign and political risk in Europe. Bond yields rose, bank stocks fell and, broadly, risk assets traded weakly.

The Berlusconi Yield Bounce
Europe just looked pretty ugly Monday. Beginning in Italy, 10-year government bond yields crept to two-month highs, Monday, on fear that former Prime Minister Silvio Berlusconi may be gaining in the polls ahead of the upcoming elections.

It was under his regime that Italy built up massive debt levels and investors fear that a return to a Berlusconi government would ensure that austerity measures would be thrown by the wayside.

Italian 10-year government-bond yields rose as high as 4.47% Monday and climbed further to 4.55% early Tuesday before declining back to 4.45%, showing increased solvency risks in Italy. Further, two-year bond yields, a relative measure of the liquidity of a nation, rose to 1.73% Monday and climbed as high as 1.77% Monday.

The rise in bond yields as of now is not worrisome, however if yields continue to rise for successive days, it could weigh on confidence in the health of the economic and financial recoveries. Further, it would call into question the credibility of the European Central Bank, which with nothing but words sent bond yields lower over the summer.

Big Italian Banks Take Hit
Italian banks were clobbered, Monday, with Unicredit, one of the nation's largest banks, declining 8.29% and Banca Monte dei Paschi di Sienna and Banco Popolare both declining over 5%. In fact, only one stock in the FTSE MIB Index, Saipen, traded in positive territory Monday, however it is also the one company that declined more than 20% in the week before.

Moving to Spain, sovereign risk crept up as Prime Minister Mariano Rajoy allegedly funneled political money into personal accounts, according to Spanish media reports. The Prime Minister refuted the allegations, however, uncertainty surrounding the political stability of Spain is negative for the nation's sovereign debt.

Low Confidence In Spain
Spanish 10-year government bond yields rose to 5.44% Monday and climbed as high as 5.5% early Tuesday, marking the highest level for the yields since mid-December. Further, two-year bond yields rose to 2.88% Monday and climbed as high as 2.95% Tuesday before retreating lower. All in all, investors became less confident in the fiscal health of Spain due to political uncertainty.

Stock moves in Spain were similar to Italy. Financials and industrial stocks traded lower as did technology companies. All in all, Spanish and Italian bonds and stocks simply repriced political and sovereign risk Monday, a clear sign that Europe still has a long way to go before it fully exits its crisis.

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