August 3, 2011
The euro zone's disease has taken a strange turn since the last summit on July 21st. The medicine that leaders prescribed immediately improved the situation of countries in the emergency room, ie, Greece, Ireland and Portugal, which have all received bail-out loans. But it worsened the condition of those outside hospital who had started to fall ill.
This contradictory effect is apparent from our charts showing the direction of yields on sovereign bonds, which move inversely to the price.
The “spread” over 10-year German bunds is the standard measure of perceived risk. It is the premium, or additional interest, that markets demand for holding the debt of a euro-zone country compared with the bonds isued by Germany, deemed the safest.
Until last month's summit, the worry was focused on whether Greece would be able to repay its debts, and whether its sickness would infect bigger countries. Leaders of the euro area decided greatly to extend maturities on Greece's rescue loans and to cut the interest rate it pays. Ireland and Portugal got the same prescription.
In addition, Greece got a bit of local surgery, in the form of a slight “voluntary” haircut on private creditors. Many think wholesale amputation is what is really needed to save Greece. But for now the aspirin and antibiotics have brought down the fever somewhat, as is apparent in the left-hand chart, Ireland and Portugal are faring better too.
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