Spanish and Italian bond yields

Spanish and Italian 10 year bond yields have dropped by 76 and 61 bp respectively since the end of July, driven by rumours that the ECB will act to cap spreads against the equivalent German yields. The Bundesbank remains vehemently opposed to this idea and the ECB has denied the rumour but there is no smoke without fire as the saying goes. It may be that European policy makers are moving to transform the ECB into the mroe traditional and flexible central bank that it needs to be if there is to be any resolution to the ongoing euro crisis but there are many issues to be resolved if this is to happen. Given the glacial speed that European policy makers move at, it is more than likely that the crisis will reemerge yet again to be followed by more frantic meetings. Investors remain caught between two opposing outcomes. If the ECB monetizes, equities will rise and bonds fall; if it doesn't, we will have the reverse. The odds favour the latter outcome as Europe's track record is one of reacting to events by indulging in more bail-outs adding yet more debt to an over-indebted set-up and refusing to tackle the insolvency that plagues so much of Europe's financial system. That said, don't rule out some form of monetization. Global growth is weakening and the outlook for China is deteriorating. The pressure is on all central banks to indulge in some form of further QE and the ECB in particular as austerity drives so many of the PIIGS' economies into the ground. Perhaps there is more to the fall in Spanish and Italian bond yields than meets the eye.