Eurozone update

Two key measures of Eurozone risk have improved on the margin. The top chart shows 2-yr Eurozone swap spreads, and the bottom shows the yield on 2-yr Spanish government bonds. Both begin at the beginning of last year for some perspective.

The 10 bps decline in swap spreads in the past week or so is impressive by itself, and more so since it takes swap spreads back to the levels of late July last year, when the Eurozone crisis was just beginning to heat up. The ECB's liquidity injections have managed to restore a lot of confidence and liquidity to the Eurozone financial market, and that is an essential first step to allowing the crisis to play itself out.

The 100 bps decline in Spanish yields is also noteworthy, if only because it shows that the atmosphere of panic has been alleviated to some extent. Instead of worrying about how much one might lose if Spain defaults over the next year, the market seems to be paying more attention to how much extra yields one might ear if Spain doesn't default.

This chart of the Vix index shows that with the edge taken off of the panic in the Eurozone, U.S. markets have relaxed considerably. Implied volatility is still somewhat elevated, but it's nothing to be greatly concerned about.

Despite the fact that U.S. markets have calmed down considerably, the Vix/10-yr ratio remains very elevated. That's mostly due to the extremely low level of 10-yr yields, and that in turn is a reflection of the market's belief that the prospects for economic growth in the U.S. and the world are dismal.

Good and bad news: the risk of a catastrophe has declined significantly, but the market holds out very little hope for any significant improvement. Pessimism still reigns.