Europe Back To Abnormal As Spanish Selling Resumes

A funny thing happened in European peripheral bond markets: they sold off - Spain is wider across the board, with the 2 Year back over 4%, and the 10 Year threatening to blow out above 7% for the first time since the market was re-re-fooled by Draghi. Same in Italy, where the 2s10s is once again in flattening mode. In other words after getting Draghi right for one day, then flipping and confusing what he said for the next week, the market is back to being right in itis initial kneejerk reaction to the ECB head's words. One reason (among many) - a Rabobank report by Richard McGuire and Lyn Graham-Taylor which states that Spain won’t ask for more aid if more conditions are attached add to likelihood "crisis must worsen before it improves." Hmm, where have we seen an identical turn of the phrase before. Oh yes, here. Rabobank also adds that the ECB will have to show willingness to buy across the curve (not just in tenors of less than one year) when it does intervene. Of course, for that to happen, things must get far, far worse. Just as we explained to the five-year olds in charge of the market this past weekend.

In other more fundamental news, Spain's June workday adjusted Industrial Output dropped -6.3% more than the -6.2% estimate. Worse, Spain is now targeting a deficit of 4.5% of GDP in 2012 for central government vs 3.5% in the previous plan sent to European officials in April. By the time the year is over expect this number to be a "shocking" 8% or more. Additionally, Italian banks’ bad loans rose 15.8% in June according to the Bank of Italy. Perhaps Draghi should tell balance sheets to 'Believe him" that all shall be well too. Finally, Germany is falling ever deeper into recession, as confirmed by the latest economic print - June Germany industrial production which dropped -0.9% M/M, vs an estimateed -0.8%, and a previous change of +1.7%. Remember: the worse Germany gets, the less leverage the periphery has of "dragging it to the bottom"... especially if it is already there.

German Industrial Production.

Bottom line: the selling sabbatical in Europe is over.