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 aboutthe 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.