Betting against the creditworthiness, or continued euro-area membership, of Portugal, Italy, Ireland, Greece and Spain, has become a mainstream activity. Once the province of marginalised euro-sceptics and sensation seeking columns (such as this one), it seems to be attracting more attention, in part because it has been so profitable. For example, back in late June, when we last reviewed this euro spread-widening trade, the extra interest (spread) paid by Italian 10-year bonds over that of German 10-year bonds was about 50 or 60 basis points. Recently, it has been closing on three times that level.

However, I am now beginning to think that the forces that created the success of the trade could turn it into a trap. Betting against a sovereign government, and winning, should make one very nervous. As long as there was no imminent threat of euro-area financial crises, the euro spread-widening trade was an entertaining and profitable game that could be executed with low transaction costs and little execution risk. Before the autumn’s credit crisis the dealers and banks were perfectly happy to pick up a basis point or two selling total return swaps that let speculators go short one euro-country’s issuance, and long another’s. The real problem with selling the risk/reward to one’s partners was that for many months, or even years, shorting the weaker European economies was less than gripping.