As most investors who were long stocks would like to forget last week's market action, PIMCO Chief Executive Officer Mohamed El-Erian offers three developments of which to be cognizant for the week ahead.
As El-Erian comes from the world of bonds by way of PIMCO, the world's largest fixed-income money manager and home of "Bond King" Bill Gross, all relate to various sovereign debt features of the euro zone crisis.
The first isCurve Inversions of sovereign debt yields. According to El-Erian, these are "often seen as often indicative of a potential tipping point -- when market perceptions of a liquidity problem risk turning into a self-fulfilling solvency concerns."
The inversion of Italian two-year bonds with ten-year years at 60 basis points, if sustained, could result in "Italy losing market access and having to resort to a bailout." Two-year debt yields should be lower than their longer-term counterparts because the longer the money is tied up in a bond, the more risk that something might go wrong.
When a yield curve inversion results, a recession is projected as investors expect long-term interest rates to fall. This happened in Greece, Portugal and Ireland.
The next development to monitor is the yield of European debt fromGermany and France compared with U.S. Treasury comparables. These spreads widened last week, an adverse condition for the needed stability of "Europe's core bond markets."
Having to offer higher interest rates to attract buyers means that German and French sovereign debt is weakening before the international investment community. That is not a welcome development for financing a rescue package for the euro zone.
A number ofpolicy announcements this week are the third factor at play, as detailed by El-Erian. These policy proclamations must be well-received to be successful. As El-Erian pointed out, "Well crafted announcements (and related prior actions) can normalize the Italian yield curve and stabilize the bond market for core countries."