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Important Breakdown in Euro, Coupled With a Breakout in Key European Debt Yields

|Includes: EUO, iShares MSCI Italy Capped ETF (EWI), EWP, GRDOW

 Our pal Brian Hunt points out today in his must-read Market Notes column that the euro has broken down through key support levels:

Euro crash 2011(Source: DailyWealth)

Brian writes:

If a country runs its finances like a drug addict and racks up crazy debts, its currency depreciates over the long term.

Most smart analysts put the status of the European Union's balance sheet in the "drug addict" category. In order to pay for all sorts of bailouts and handouts, nations like Greece, Ireland, Portugal, and Spain have run up impossible debts. Bond and stock prices are plummeting in those nations as they struggle to pay them back. Bank stocks in Portugal, for instance, just struck 15-year lows.

All this is hard on the paper currency backing the mess, the euro. As you can see from the chart below, the euro enjoyed a rally in late 2010 as folks got to thinking things were great. But in the past few months, the euro got clobbered... and just last week, declined past $1.30 to reach an important new low. The race to the lower right-hand side of the chart is on...

Source: DailyWealth

As the euro slides towards the lower right, yields on European sovereign debt continue their climb towards the upper right - first stop, Greece:

Greece 10 Year Bond YieldSince the EU's "shock and awe" bailout of Greece, yields have resumed their inexorable climb, and now stand perched near all-time highs once again. (Source: Bloomberg.com)

Economist Kenneth Rogoff of This Time is Different fame was in the news a few days ago, commenting that a Greek default would not surprise him.

Meanwhile yields on Spain's 10-year continue their "breakout" to the upside:

Spain 10 Year Bond YieldSource: Bloomberg.com

And the REAL elephant in the room, as our astute correspondent Dr. Evil has frequently pointed out, it Italy - spreads on Italian debt continue to break out, signaling a big fat RED FLAG:

Italy 10 Year Bond Yield January 2011Source: Bloomberg.com

With Italy's debt-to-GDP ratio of approximately 120%, these rising yields are a very serious matter.  A bailout of Italy would run a cool $1 trillion or 2 - not an option with the current funds in the EU bailout piggy bank.

Some believe the US would become the lender of last resort, because we run the world's printing press.  Others believe it's more likely that Italy will bow out of the EU as soon as this year - so that it can devalue and/or default again.

Either way, something has to give!

And economic growth is unlikely to come to Italy's rescue - its economic growth lagged much of the rest of the world in the 2000's, and thedemographics of Italy are a complete disaster as well.

Normally I'd say that things are likely to get worse before they get better - except with the demographic Sword of Damocles hanging over the entire equation (both for Italy, and more broadly speaking, Europe), I think we can only conclude that things will get worse, and probably soon!



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.