All HECK BREAKING LOOSE or JUST the START of a SIGN OF THE TIMES?

Events are so fluid that before I can finish this post, something major is likely to have happened, but it is important that you UNDERSTAND the backdrops that underpin the market right now or else technical or any other analysis will be useless. Basic understanding of the issues is all I'm trying to convey, not a live commentary on world breaking news. My post from Sunday, laid out many of the main events to watch for and what is just what I call the "sugar high news of the hour". Understanding the difference between what is important and what is a sugar high gives you the ability to enter shorts as I had recommended on Friday's strength and at which you would already be at a nice profit on. So here's what has happened overnight as 3 a.m. EDT in the US, is when the European markets open and all hell breaks loose.

Overnight:

On the overnight (in the US) European opening, all bonds of just about every nation moved to worse levels, the higher the yield, the more interest a country has to pay to borrow money and at some point it becomes impossible to sustain those high interest rates, that is when a country is "Locked out of the capital markets" and is forced to seek a bailout like Greece, Ireland and Portugal. Italy, which is 6 times bigger then Greece and the third largest economy in Europe seems to be the country that could cause it all to come crashing down and then the EU is beyond redemption, but Spain is very large too and for weeks, maybe months, has been out of the spotlight as if all was well there. I warned on Sunday that this would change VERY soon, I didn't realize that it would change Monday morning and today it is nearly overtaking Italy as a sign of major market trouble for the EU and by extension, the rest of the world including and maybe much worse then we realize, China as the EU is China's main trading partner.

So overnight on the European opening, France (this is a sign of what was once termed contagion of the PIIGS -Portugal, Ireland, Italy, Greece and Spain- causing trouble that would possibly hit the core, France, Germany and most of the northern EU countries) saw the spread (this is a measure of how a country's bonds are performing against a benchmark which is German bonds) hit a new all time high, meaning that the one country that the European Central Bank (ECB) cannot support in the secondary bond markets, is the one under attack as investors look to accurately asses risk, which can't be done with Italy or Spain as the ECB buys their bonds in the secondary market to support them, this gives a false value and price discovery is irrelevant, so bearishness is being expressed via French bonds and in doing so, is causing that which has been most feared "Contagion of the Core EU countries".

As a result of both Spanish and French 10 year notes hitting all time record wides vs Germany's, the EFSF bailout mechanism (Bonds) themselves have also come under attack from bond traders and are also hitting new all time record wides vs the German benchmark. The bottom line, things are going from bad to worse.

Italy which hit record yields for the country just a week or so ago, above the 7% level, which is widely seen as the point of no return because Portugal, Ireland and Greece (all 3 countries who have received bailouts) all asked for bailouts within a week or two of their bonds hitting this unsustainable level of debt interest, started moving higher today toward the all time record. For the countries mentioned above,  effectively it became too expensive for them to borrow on the open market, the same way we do in the US by selling treasuries. The interest rates where too high and they couldn't repay them, which eventually would lead to the dreaded default, the point at which they can no longer make those payments to the holders of their debt, which is the ultimate bad ending. That is what is happening in Italy, Spain and starting to happen in France.

Today the Spanish tried to auction off $4 bb in 10 year debt notes (like out treasuries), they were only able to sell 3.56 bb so the auction was deemed a failure. When there are more bidders for the debt then there is debt available, the yields the country has to pay drop, but when they can't even sell what was planned, they sky rocket and as an example, the same Spanish bonds were sold a mere 3 weeks ago for 5.433%, today they went for 6.975% which is just shy of the 7% point of no return. So Spain has reemerged very quickly as a point of big trouble.

Furthermore, the Spanish spread vs the benchmark German bunds hit an all time record of 499 basis points. You should be reminded that LCH hiked the margin requirements to trade Italian bonds when their spread hit 500 basis points, when that happens, bond traders must put up more money or sell positions and what tends to happen is there is a lot of selling which in turn causes bond yields to rise even further creating more pressure on Spain, Italy, France and others as well as the EFSF bonds.

As mentioned, French Bund Spreads vs German were at 175 basis points earlier in the week, they are now at 202 which is a new record.

Later in the morning the ECB (European Central Bank) did intervene in the secondary bond market and bought debt from every country trying to lower the yields, they especially focussed on Spain and Italy, but as we have seen time and time again, they spend billions to support these bonds and an hour later it is as if they did nothing as yields move higher, this leaves the ECB with a ton of toxic paper on their balance sheet and they have a limited amount to work with, around $400 bb euros, of which they have already spent more then half.

To make matters worse, this morning the rating's agency Fitch said,

FITCH SAYS ITALY RATING MAY BE CUT IF IT LOSES MARKET ACCESS

FITCH SAYS ITALY RATING COULD BE CUT TO LOW INVESTMENT GRADE

FITCH SAYS ITALY IS PROBABLY ALREADY IN RECESSION

Also as per Reuters

ECB could lend to IMF for euro zone rescue -officials

As I pointed out in an interview with a German ECB member in an interview on Sunday, he was asked directly about the ECB lending to the IMF and let the IMF buy the debt of these countries as the ECB is prohibited by treaties and law to do so, he responded that that can not happen.

However the pressure on the EB from all over the world to at as lender of last resort is immense, the problem, it breaks their laws and Germany is strictly against it.

Peter Tchir of TF Market Advisors says the following about this development,

The ECB may be considering using the IMF because the IMF can demand collateral or better terms on its loans than the ECB?  The IMF does try and become a senior lender.  If that is the case, than this can actually be really bad for existing debt holders.  Especially if it is coming as a realization that SMP's have been totally useless in sustaining the crisis and have done nothing but stuff the ECB's balance sheet full to the gills with weak assets and helped some quick traders make a nice profit.

Be very careful with this rumor.  As with so many other half baked "plans" (found on a discarded cocktail napkin after a 3 martini lunch) , the likelihood of this occurring seems low, and I highly doubt it will have the impact people want or hope.

Here's a look at this morning's record debt in the EU (whether you understand the European consequences of their bonds or not, you should have little trouble understanding the importance through these harts-all bearish, all today):

 The bailout mechanism, the EFSF bond spread vs benchmark German Bunds, you can see the trend is up and rather quickly, this means the yields to hold this bailout paper are rising. As a reminder, they need to raise nearly a trillion Euros and have had trouble with their only auction of raising a simple $3 bb Euros.

 Here is the French Bund Spread vs the German, in little less then a month, it has nearly doubled, contagion has hit the core.

Here are the Spanish spreads vs the German benchmark, from 380 to 499 in 12 days-MAJOR PROBLEMS

In some other ominous news, if MF Global is the Bear Stearns of 2011, Jefferies which was in trouble and subsequently managed to talk themselves out for a short period, is back in trouble and may become 2011's Lehman Brothers.

In red to the left was the first period of market trouble for the very same reason as MF Global, exposure to European debt. They managed to talk themselves out of it briefly although the stock was halted in trading several times in a day as circuit breakers kicked in. The white is when they though they had convinced the market they were okay, it didn't last long and now they are at new lows as they are seen as the next MF Global or Lehman Brothers.

As for the Technical government in Italy led by Monti, which rallied the market earlier this week... As much as Berlusconi was despised, it seems Monti is already is big trouble, which may pave the way for the worst outcome for Italy, elections scheduled for next spring of 2012.

Milan students protest against "bankers' government"

In Turin, clashes broke out between police and thousands of demonstrators including anarchists trying to approach the local headquarters of the Bank of Italy.

Police said several people had been injured, including a policeman. Some of the protesters chanted: "Smell of austerity" and "Monti will all make us beggars."

A collapse of market confidence has pushed Italy to the brink of financial disaster and driven up its borrowing costs to unsustainable levels.

Monti's cabinet is made up of a mix of academic specialists and experienced administrators and includes Corrado Passera, the chief executive of Italy's biggest retail bank, Intesa Sanpaolo, as industry minister.

And here at home, the OWS movement is converging on the NYSE, setting up likely violence with riot police, here's the live feed:

Chart and market updates are on the way next.