Below we show graphically the heightening risk trade in Europe. Although the EU community, IMF, World Bank, and ECB continue to backstop or subsidize the debts of the region’s fiscally bloated countries, the threat of the rising cost of capital remains significant in a world of interconnected risk.

The proverbial ‘PIIGS’ have shown a clear negative divergence across capital markets over the last week, with sovereign CDS spreads blowing out after significant declines in September and most of October (see chart below). Importantly, as Ireland’s ability to meet its sovereign debt obligations this year and next are called into question, Ireland’s CDS rose to a new high of 499bps, as the yield on the country’s 10YR bond widened to 7.22% (or 477bps over German Bunds), the highest yield since the mid-90s. Equally, yields are blowing out in Greece, Portugal and Spain.

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From a quantitative set-up, Spain’s equity index, the IBEX 35, broke its intermediate term TREND line of support at 10,726 today, while Greece’s ASE Index remains broken on both the TREND and immediate term TRADE durations, and is the worst performing index across all global equity indices year-to-date at -30.8%.

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As the risk premium expands for Europe’s fiscally weaker nations, we want to reiterate our cautious outlook on the region. While we continue to like Germany’s fiscal austerity and relative growth profile into year-end and in 2011, we expect the region’s growth to slow as austerity measures squeeze the consumer via higher VAT, job losses, and wage freezes. Below we chart data out today on the Manufacturing PMI. While the data shows that most countries gained in October versus September, we do not expect to see marked improvement in this data into year-end as Austerity’s Bite plays out.

We’re currently short Italy in the Hedgeye Portfolio via the etf EWI.

Matthew Hedrick

Analyst

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