European Update: Mixed Signals Warrant Caution

By Win Thin

Euro continues to have trouble making a clean break of 1.30. However, with market sentiment in an upswing right now, it appears that it will continue to probe the upside for the euro, so further dollar losses appear likely. Peripheral bond spread tightening accelerated this week, with 10-year Portugal bonds tightening to Germany by 31 bp today.

Greece and Spain 10-year bonds tightened by 11 bp today, Ireland's by 20 bp. While the improved sentiment regarding Europe cannot be ignored, we stress again that these spreads all remain very elevated by historical standards.

Same thing can be said for the 5-year CDS prices for the peripheral countries. Indeed, analysis shows that current CDS prices for Greece imply a default probability that approaches 50% in 5 years. For Portugal, this probability approaches 20%. For Spain, about 12%. Overall, we remain a bit cautious and note again that interbank rates in Europe are still going up, not down.

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