In a financial crisis, bond yields provide a real-time gauge of whether a country’s prospects are getting better or worse. If a country’s outlook is worsening, the market will demand higher yields on its new bond issues and the government will have no choice but to pay. But those higher yields raise a struggling country’s borrowing costs, intensifying the debt burden on its already cash-strapped government. This creates more investor fear, and subsequent bond yields must be raised again, and again, and again. It is a cycle of fear that feeds on itself.
Last week, the yields on the euro zone’s latest round of new bond issues indicated that the region’s financial crisis has reached a new level of urgency. Simply put, the bond-yield gauges for Italy and Spain are now red-lining. Let’s check out the difference in their government bond yields last week versus one month ago: