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Financial conditions in Europe are on the mend

Financial conditions in Europe are gradually becoming less anxious, as these two charts show. The yield on 2-yr Greek government debt has dropped more than 400 bps since August, reflecting a much-reduced chance of a Greek default. Meanwhile, 2-yr yields on German government debt have risen 20 bps, suggesting less concern that Greek woes will drag down Germany.

Swap spreads (see my primer on swap spreads here) in the U.S. have been trading at very low levels for most of this year, which is a very good sign that financial conditions here are essentially back to normal. Counterparty risk, according to swap spreads, is actually rather exceptionally low, which is one anticipated effect of very accommodative monetary policy. European 2-yr swap spreads have dropped 25 bps since their early-June peak in a sign that the risk of a Eurozone financial meltdown (presumably triggered by a Greek, Irish, or Spanish default) has dropped considerably.

It shouldn't be surprising that the improvement in European financial conditions has largely coincided with the rally in U.S. equities, since it was the fear of a Greek default back in April that triggered the market's selloff that lasted through early July.

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