Europe’s wildcard – Italy

Europe’s wildcard – Italy

Europe’s wildcard, Italy is likely to remain in focus

Italian 10yr Government (sovereign) bonds yields (at the time of writing this piece) have spiked to 3.1% near their 52 week high. Europe’s wildcard, Italy is illustrated in the Italian 10yr sovereign bond chart (Source: Marketwatch)

The Italian 10yr bond chart is saying is that private investors are ditching Italian government debt over concerns about Italy’s new populist anti-establishment government.

Moreover, with talk of the major buyer of European bonds, the European Central Bank (ECB) now wanting to take less of an active role in bond purchases this is making European bonds, particularly Europe’s peripheral bonds less attractive. Investors have been bracing themselves for the ECB’s move to monetary normalization policy which would entail winding down (tapering) its massive Asset Purchase Program (also known as qualitative easing). The ECB is currently purchasing 30 billion euros of bonds purchases per month.

Europe’s wildcard, Italy could be the catalysts for another eurozone sovereign debt crisis

Italian government debt was equivalent to more than 130 percent of the country’s gross domestic product (GDP) in 2017. Italy has been able to keep repayments down thanks to the interest lowering effect of the European Central Bank’s asset purchase program.

When the demand for anything is less than its supply then the laws of market dynamics suggest that its price will fall. As the demand for Italian sovereign debt falls so too does the price of its bond which also increases its yields, bearing in mind that there is an inverse relationship between bond price and yields. So as Italian 10yr Government yields near 2014 highs (over 3%) that also raises the cost for the government to service the debt.

Europe’s wildcard, Italy has sovereign 10yr yields approaching breaking point

Sovereign investors decision to dump Italian debt (which has sent their corresponding yields soaring) is putting Italy’s populist government’s finances on an unsustainable track before even having spent a single euro. The country’s mound of debt would over time become too expensive to finance, according to Bloomberg Economics’ calculations. With Italian 10yr yields approaching 3.5 percent, the debt ratio is now on an upward trajectory.

Note that Italian 10-year bond yields shot above the 7 percent during the euro 2011 euro sovereign debt crisis. If Italian yields were to rise to such a level it would make it impossible for the government to service its debt and a sovereign debt default would soon follow.

Europe’s wildcard, Italy is likely to trigger a European response

During the 2011 sovereign debt crisis, German Chancellor Angela Merkel got on her soapbox, as Italian 10-year bond yields smashed above the unsustainable 7 percent level. “Deep structural reforms were needed quickly…that will mean more Europe, not less Europe,” Merkel told a conference in Berlin.

But EU’s response to Europe’s 2011 sovereign debt led to crushing austerity in the south and massive undocumented immigration due to the blowback of the Syrian war. More Brussels superstate and less national self-determination regarding voter hot-button topics such as national budgets and immigration fuelled the rise of Brexit and Euroscepticism.

Europe’s wildcard, Italy is likely to trigger a European response. But will the EU get it wrong again?

Europe’s wildcard, Italy offers the US leverage when it comes to negotiating trade deals with the EU

The US Trump administration has been quick to exploit this opportunity. The hand that gives is above the hand that takes. Rome has increasingly become desperate to replace the private investors who are fleeing Italian bonds. So the US government is stepping in to guarantee the debt.

Italian media claim that President Trump has offered to buy Italian government bonds in 2019.

This is a Machiavellian move by the Trump administration. Why?
What is going on here is more than meets the eye. The US government is doing much more than financing the activity of a foreign government it is buying loyalty (like a Mafia boss).

So if Europe’s wildcard, Italy accepts US finance (and why would it not) then the new Italian populist anti-establishment government will kneel (be loyal) to their new Good-father in Washington, the US Trump administration and not the EU’s (gang of 28 members).

What this means is that the US government has now more leverage (the upper hand) when negotiating a favorable trade deal with the EU.

Moreover, with Europe’s wildcard, Italy likely to fall into the US’s remit, the Italian government could also be used as a soldier sent to Brussels to end the euro. What if behind closed doors the US administration is plotting to end the euro?

It is no secret that the US is eager to rebuild its manufacturing industry (see the America first of Trumponomics) and Europe’s one currency fits all model could be viewed by some in the Trump administration as holding back US ambitions to rebuild its manufacturing.

The Euro is too weak for Germany which is providing German exports with an unfair competitive advantage making it difficult for the US to compete and that is also creating trade imbalances. But for the southern countries, the Euro is too strong. Italian manufacturers have long argued that the euro is making their goods too expensive in foreign markets and would prefer the return of the Italian Lira.

Furthermore, the sovereign bond market has become too crowded, a beauty contest with a lot of offers and not enough bidders. Making the euro less stable makes US paper more attractive.

Is Europe’s wildcard, Italy a classic contrarian play?

Italian sovereign debt has become politicised. The ECB will do whatever it takes to save the euro.

So the ECB will most likely buy Italian debt. Meanwhile, the US government is also planning to buy Italian government debt (for different reasons). Here is the takeaway, in a nutshell, Italian 10yr sovereign bond which is currently yielding over 3% with potential big buyers in the pipeline could now be on sale. Over to you.