For the time being, shock and awe has reduced sovereign debt yields in Greece, Spain, and Portugal.

However, global corporate bond yields are going the other way. Please consider European Debt Woes Punish Corporate Borrowers.

Europe’s sovereign debt crisis is punishing corporate borrowers, with bond issuance tumbling as investors doubt a $1 trillion bailout plan will be enough to bolster confidence in government finances for the region.

Borrowers worldwide have sold $15 billion of corporate debt this month, a 62 percent decline from the same period in April and 83 percent less than the average for the past year, according to data compiled by Bloomberg. The extra yield investors demand to own corporate debt instead of government bonds soared last week to the highest in more than four months.

Corporate bonds have lost 0.47 percent in May, the worst start to a month since February, according to Bank of America Merrill Lynch index data.

Given last week’s volatility in nearly everything but gold, it is hard to be certain what is going on with corporates. However, if corporate bonds have topped (yields bottomed), the equity markets will be in for a rough ride.

Public Sector Wage Cuts In Spain

Inquiring minds are reading EU imposes wage cuts on Spanish “Protectorate”, calls for budget primacy over sovereign parliaments

Premier Jose Luis Zapatero told a stunned nation that public sector pay will be reduced by 5pc this year and frozen in 2011. “We must make an extraordinary effort,” he said.

Pension rises will be shelved. The country’s €2,500 baby bonus will be cancelled. Aid to the regions will be slashed and infrastructure projects will be put on ice. Mr Zapatero’s own monthly pay will fall 15pc to €6,515.

Commission president Jose Barroso unveiled plans for EU control over national budgets, including an incendiary demand that Brussels should vet budgets before their first reading in Westminster, the Bundestag, and other parliaments. Current account deficits and credit growth will be monitored. Brussels can imposing sanctions on states that let booms run out of control. “We must get to the root of the problems,” he said.

Such a plan would greatly improve the working of the EMU system, but it would also entail a drastic erosion of sovereignty. The intrusive surveillance is a wake-up call for states that have tended to view the euro as a free lunch.

US President Barack Obama played a key role behind the scenes, pleading with Mr Zapatero for “resolute action”. The telephone call from the White House is a clear indication that contagion from Greece and Portugal to the much larger debt markets of Spain had become a global systemic threat by late last week.

Spain’s wage cuts amount to an “internal devaluation” within EMU. Stephen Lewis from Monument Securities said the EU is pushing a clutch of countries into contractionary policies at the same time. These will feed on each other, creating a deflation bias across the region akin to the ‘Gold Bloc’ in the 1930s.

“It is not a viable policy. Weakening demand will cause the tax base to shrink. If the population could see light at the end of the tunnel, they might put up with it, but there is no light: it is a long dark passage leading nowhere,” he said.

Public sector wage cuts are a step in the right direction. Now if only President Obama would relay the same message here.

EC Proposes New Economic Rules

Please consider Brussels eyes tougher fiscal discipline rules.

The European Commission on Wednesday proposed tougher rules to enforce fiscal discipline in the eurozone and to set up a permanent crisis management mechanism to prevent sovereign debt disasters.

The initiatives, if approved by national governments, would represent the most significant advance in eurozone economic governance since the euro’s launch in 1999.

Among the most important proposals is the idea that national governments should assess each other’s annual budgets in greater detail and much earlier than is now the case. While they would not have the power to force a country to rewrite its budget, they would be able to exert pressure to make the budget’s assumptions about economic growth, inflation and interest rates as realistic as possible.

The European Union’s fiscal rulebook, known as the stability and growth pact, would be tightened so that more emphasis was placed on the need for governments to cut public debt.

For example, any country with a debt of about 100 per cent of gross domestic product would be told to keep its annual budget deficit not just below 3 per cent of GDP but so far below that it produced a steady reduction in the debt level.

Olli Rehn, the EU’s monetary affairs commissioner, acknowledged that the stability pact, drawn up at German insistence in the mid-1990s, had fallen short of expectations.

“Peer pressure lacked teeth. Good times were not used for reducing debt. And macroeconomic imbalances were ignored,” Mr Rehn said.

The details of the new mechanism remain to be fleshed out, but Mr Rehn said it would be “a last-resort mechanism of financial assistance in the form of loans, with interest rates that would be so unattractive that no one would want to use it voluntarily”.

There are no details yet, just vague ideas. After the European Commission hammers out details, countries will have to vote on them.

Will countries cede their fiscal sovereignty to the EC? I doubt it, and if not, we all know peer pressure does not work.

Mike “Mish” Shedlock
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