The Spooky Tale of Italy’s Yields

10/31/2011 10:55 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Investors are increasingly reluctant to buy the country’s bonds, suggesting worse days ahead for Europe’s debt crisis, writes senior editor Igor Greenwald.

The most telling of last week’s numbers wasn’t the €1 trillion in sovereign bond purchases Europe hopes to spur with partial insurance against default.

It wasn’t the 1,869 points the Dow Jones Industrial Average had gained from the October 4 low by Friday’s close.

It wasn’t even the 94% of S&P 500 stocks trading above their 50-day moving averages as of Thursday, though that was the most impressive show of bullish unanimity in at least five years, according to Bespoke Investment Group.

No, the key figure of the week was 6.06%, which was the unaffordable and record interest rate Italy was forced to pay on its new ten-year notes Friday.

Europe’s entire game plan for tackling the debt crisis aims to let Italy borrow the hundreds of billions it will soon need much cheaper than that. And the investors the Eurozone most needs to persuade—the potential buyers of Italian and Spanish bonds—aren’t buying the plan just yet, and may never do so in sufficient numbers.

Why should they, when the Italian bonds sold next year might come with as-yet-unavailable credit protection? And, more importantly, why should they when Italy, of all the European countries not yet rescued, is most likely to have trouble paying them back?

In crafting the broad outline of the latest bailout last week, European leaders were vehement that no other country would require a restructuring of the sort set to cost private Greek lenders 50% of their principal. The only problem is that, 18 months ago, Greek debt was said to be similarly sacrosanct.

So now the market doubts Europe’s will to print money, if necessary, to save Italy—and Italy’s €1.9 trillion debt mountain is so high that printing money is looking more and more like the only realistic exit strategy.

This is especially true because the Italian government’s drive to balance the budget by 2013 will further drain growth that has already been minimal for decades. Italy’s fractious and discredited government lacks the will to push through the structural reforms that Germany insists will turn the tide.

While Europeans race to flesh out the bare outline of their bond-insurance plan, the negative feedback loop already in effect means that the more Italy’s yields go up, the more unsustainable its debt looks, which means that yields go up yet again. Italian banks were not invited to the global market party last week because the world doubts their ultimate ability to collect on the Italian sovereign debt on their books.

Other problems have emerged for Europe, as predicted here last week. Greek protests in the aftermath of the latest restructuring suggest that Greece won’t be able to withstand another eight years of austerity, which—in the best-case scenario—will leave it no better off or more creditworthy by 2020 than Italy is today.

 In Portugal, people have started hoarding money the way they were doing in Greece shortly before that economy went into a tailspin. Business sentiment surveys throughout Europe are flashing recessionary signals, as companies, banks, and consumers retrench.

Europe’s plan to leverage its rescue fund means that a relatively modest deterioration in the value of the sovereign bonds it will insure could wipe out most of the insurance kitty. That’s why France runs the risk of a credit downgrade once details are in place, and why it has been so anxious to draw in rescue cash from Asia and the International Monetary Fund.

But outsiders won’t bail out Europe so long as it refuses to help itself by using its powers to print money as the US, UK, and Japan have done. And Germany, which has the last word on all European issues these days, insists that the European Central Bank doesn’t have that power.

So long as Berlin clings to the fantasy that austerity and structural reforms will save the day, expect the debt crisis to get even more dangerous.

  By clicking submit, you agree to our privacy policy & terms of service.

Related Articles on GLOBAL