The 7% Yield Myth

The 7% myth. We have heard a lot about what it means to cross the 7% threshold. It definitely used to be pretty much a one way ticket to destruction – Ireland, Portugal, and Greece are all prime examples.

In November, Italy hit 7% and the EU responded. The response came in fits and starts and the market was skeptical, yet in the end they were able to push yields much lower.

Spain hit 7% and the EU response looks even more aggressive than post Italy and nothing like responses to Ireland, Portugal, and Greece. Today the Irish 10 year is below 7% and even Portugal has managed to get to 9.28%.

I’m not suggesting anything is fixed, or that things can’t get worse, but it is very difficult to fight overwhelming liquidity. We can look at the situation as a rational investor and it should implode. The ECB is not a rational investor. It can make decisions that aren’t justified by analysis because they do have the ability to print money.

If Germany is truly willing to promote spending (they call it growth, but it really is just spending) and is willing to let the ECB and the EFSF/ESM take real risk, then they can push markets pretty far. Their strategy does seem to have evolved into getting the amount of bonds held in trading accounts down in an effort to create short squeezes, like we are allegedly seeing at the front end of the Portuguese curve.