High borrowing costs bode EU rescue for Italy
Time ‘running out fast,’ warns analyst as national debt soars
LONDON — Italy is likely to need an EU rescue within six months as the country slides into deeper economic crisis and a credit crunch spreads to large companies, a top Italian bank has warned privately.
Mediobanca, Italy’s secondbiggest bank, said its “index of solvency risk” for Italy was already flashing warning signs as the worldwide bond rout continued into a second week, pushing up borrowing costs.
“Time is running out fast,” said Mediobanca’s top analyst, Antonio Guglielmi, in a confidential client note. “The Italian macro situation has not improved over the last quarter, rather the contrary. Some 160 large corporates in Italy are now in special crisis administration.”
The report warned that Italy will “inevitably end up in an EU bailout request” over the next six months, unless it can count on low borrowing costs and a broader recovery.
Emphasizing the gravity of the situation, it compared the crisis to when the country was blown out of the Exchange Rate Mechanism in 1992 despite drastic austerity measures.
Italy’s national debt of 2.1 trillion euros ($2.89 trillion Canadian dollars) is the world’s third largest after the U.S. and Japan. Any serious stress in its debt markets threatens to reignite the eurozone crisis. This may already have begun after the U.S. Federal Reserve signalled last week that it will begin to drain dollar liquidity from the global system.
Italian 10-year yields spiked to 4.8 per cent, up 100 basis points since the Fed began to toughen its language in May. But Mediobanca is particularly concerned about the gap that has emerged between yields on short-term bills (BOTs) and longer-term bonds (BTPs) near maturity that expire at the same time. BOTs retiring on July 31 are trading at a yield of 0.48 per cent, while the equivalent BTP is trading at 0.74 per cent. The reason is that BOTs are protected from debt restructuring.
“The bills never get a haircut, so people are fleeing bonds instead as positions get squeezed,” said one City (London) trader.
Sovereign debt strategist Nicolas Spiro said “taper terror” is jolting eurozone investors out of their complacency, though safe-haven Swiss and German bonds have also sold off sharply in the rout. Yields on 10-year U.K. Gilts closed at a two-year high of 2.53 per cent.
Yields hit 5.1 per cent in Spain, and 6.7 per cent in Portugal. This is sending a secondary shock wave through their corporate debt markets, choking recovery.
“The European Central Bank needs to take very aggressive steps to offset this,” said Marchel Alexandrovich from Jefferies Fixed Income. “We have a sell-off across the board. If the ECB doesn’t act, it could see all the gains of the last nine months vanish in two weeks, taking the eurozone back to square one.”
The ECB has already backed away from earlier plans to steer credit to small businesses in the Club Med bloc. The Italian banking association said it was bitterly disappointed by the latest break down in eurozone talks on a banking union, warning that it leaves Italy’s lenders at the mercy of a confidence crisis.
Andrew Roberts from RBS said the world has become “a dangerous place” as Fed tightening marks an inflection point in global liquidity.
“Central bank stimulus has fed a lovely carry trade and a rising tide has lifted all boats, but unfortunately the opposite is also true,” he said. “We have clear signs in global finance of a generalized meltdown in assets right now.”
Guglielmi said Italy’s industrial output has slumped 25 per cent from its peak in the past decade, while disposable income has dropped nine per cent and house sales have dropped to 1985 levels.