The squiggles on traders' screens showing changes in the prices of government bonds are the closest thing that financial markets have to medical-monitoring machines for ailing economies. By this diagnostic measure, the invalids in Europe's medical ward are making a remarkable recovery.
On Jan. 10, the interest rate on Spanish 10-year government bonds fell below 5 percent for the first time in almost a year. Even though rates then ticked up a tad, the cost of new government borrowing is now about 2.5 percentage points lower than it was when worries over a breakup of the euro area peaked in July 2012. The Italian patient is doing well, too: The rate on 10-year Italian debt is approaching 4 percent, which is also close to 2.5 percentage points off the highs last year.
Big banks in Italy and Spain are managing to sell long-term bonds. European banks also seem likely to reduce their dependence on the lifeline extended by the European Central Bank (ECB) through its long-term refinancing operations.
Mario Draghi, the president of the ECB, says that a "positive contagion" is sweeping through Europe. The idea has some merit, but is the region really on the mend?
Draghi has made assurances that the ECB will do whatever it takes to save the euro. That sparked a burst of bond-buying by hedge funds that were covering short positions in Italian and Spanish debt.
Institutional investors such as pension funds and insurers also are returning to these markets. Part of the explanation for this is that Spanish and Italian bonds still offer juicy yields, compared with depressed rates on other assets.
Draghi's positive contagion also may play a role. Prices of government bonds do not simply reflect the underlying health of government finances but also influence them. In the cases of both Spain and Italy, debts that appear sustainable at interest rates of 3 percent to 4 percent become unsustainable if rates move persistently to 6 percent to 7 percent, making it rational for investors to keep selling bonds even as they get cheaper.
Such technical factors can also reverse, says Andrew Balls of Pimco, a bond-fund manager that has been buying Spanish and Italian bonds for some months now, after previously selling much of its holding.
"When prices are falling, people want to sell," Balls says, "and that can also work in the opposite direction. If bond yields continue to be steady or decline, if volatility continues to be steady or declines, then you ... can crowd investors in."
Confidence in bond markets is being seen as a turning point in the crisis. Some of the vital signs may be misleading, however. One worry is that the connection between weak banks and weak governments may have strengthened again in recent months. Bond traders suspect that much of the demand for Spanish and Italian government debt has come from the domestic banks of these two countries.
Still, the underlying economic picture remains grim. Germany's economy contracted in the fourth quarter. Unemployment is extremely high in peripheral countries. Spain and Italy risk missing their deficit-reduction targets. Most worrying of all is that the fall in yields may blunt the incentive for eurozone politicians to take tough decisions on reforms.
"European policymakers only move at gunpoint, and the only gun around is the market," Citigroup's Willem Buiter says.