Not so Lucky Charms in Dublin

Montreal, Canada

Europe’s sovereign debt crisis is far from over.

A pledge from the European Union (EU) to protect bondholders until 2013 drew buyers back into Irish government bonds on Friday after a shellacking recently. After Greece, Irish debt sells at the highest premium among peripheral eurozone members; yields declined to 8.48% on Friday after exploding higher since September.

Portugal might be next on the hit-list.

What’s interesting about the ongoing global rally since U.S. Labor Day is that several segments of credit have actually deteriorated over the same period.

Nowhere is the deterioration in credit markets worse than in Europe’s weak periphery.

Even as markets surged in September and October, Irish, Greek and Portuguese sovereign debt spreads widened. In the United States, investors have also become more selective in the post-2009 bond buying boom as more sub-sectors of credit finance currently pay higher rates compared to just six months ago.

Overall, however, credit markets have healed markedly since the dark days of early 2009. Three-month dollar LIBOR rates are at 0.28% — and fell again last week from 0.29% a week prior – and companies are finding buyers for just about every type of bond going to market over the past 12 months. Bond fund inflows are through the roof since 2009 and setting records almost every month.

But things don’t look too good in Ireland – and that’s unfair.

Ireland doesn’t deserve this attack from the bond market vigilantes. The country has secured funding needs through June 2011 and continues to cut costs aggressively to reduce its bloated deficits. Still, the markets are wagering that a restructuring is imminent with International Monetary Fund (IMF) assistance likely to play a role, similarly to Greece last May.

What’s truly alarming about the debt crisis in Dublin is that the Irish government is doing all the right things to balance its books. It was the first eurozone member to cut spending and introduce deposit guarantees, which expired last month. The Irish have made the biggest cuts as a percentage of GDP than anywhere else in the eurozone.

Is the sovereign debt crisis finally coming home to roost in America?

For global investors, the ongoing sovereign debt crisis in Europe is not giving a boost to safe haven assets like Treasury bonds since yields bottomed in September.

Since 1997, dislocations in world markets drove T-bond yields down (higher prices); but not lately. Instead, despite the Fed’s $600 billion dollar splurge, which is set to commence shortly and focused on intermediate-term T-bonds, both short and long-term interest rates continue to rise sharply. That’s bad news for Bubble Ben and the Fed.

The Europeans and the IMF won’t let Ireland collapse. The EUR’s future depends on bailing out these countries, regardless of what the Germans think. But over the next 3-5 years when this funding facility runs out in Europe, it’ll be up to the IMF to bailout these countries. At that point, a new EUR might surface with weaker members thrown out and the Germans anchoring the currency with the Dutch, French, Belgians, Austrians and possibly, the Slovenians.

I think the EUR is here to stay. I’m just not sure what the single currency will look like in five years if the Germans finally decide to bid eurozone bailouts “auf wiedersehen.”

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