The bond market may be understating the risk of a Spanish restructuring/bailout.
Yields have been trending higher since March but remain well-below the November highs. Meanwhile, credit-default swaps are trading at record highs.
5-year CDS vs 5-year yields:
Note that the divergence begins in March, immediately following LTRO2.
CDS market is giving a much clearer picture of the ongoing crisis in Spain. The Spanish credit crunch (and perhaps pressure from the government) is forcing Spanish banks into bonds.
The market is overly focused on Greece and underappreciating risks from Spanish credit, which could easily cause a 10-cent plunge in the euro.
Spain rolls out its bank plan on Friday and it could very well be the moment that breaks or saves Europe.
