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Commentary

Europe's Credibility Gap

European leaders need to follow up their words with actions if they want to stem the debt crisis.

Yet again, it's been a wild ride in Europe this week. Spanish (and other) bond yields whipsawed back and forth, money poured in and out of safe-haven assets, and the U.S. stock market gyrated back and forth. The forces behind these moves are nothing new. The market's fear gauge continues to move up and down based on an assessment of how willing and able European institutions are to stem the crisis. Until these institutions are able to convince the markets, once and for all, that they have the crisis under control, the volatility isn't likely to stop.

The gauge was sky-high earlier in the week as Spain remained in laser focus. Continued issues in regional governments, a huge number of unanswered questions about the pending bank bailout, and concerns about a further slowing economy sent 10-year bond yields over the 7% level. And it wasn't just long-term debt that was getting hammered; short-dated bonds took a beating, too. As Morningstar's corporate bond strategist Dave Sekera pointed out, the hefty yield on the two-year bonds indicated the market was beginning to believe that a near-term default was becoming more likely. With high short- and long-term borrowing costs, Spain could find itself in a situation where it becomes very difficult to refinance debt that is coming due. This would exacerbate the country's financial situation and send rates even higher.