The 100 billion-euro ($126 billion) rescue for Spain’s banks moved Italy to the frontline of Europe’s debt crisis as an initial rally in the country’s bonds fizzled on concern it may be the next to succumb.
Italy’s 10-year bonds reversed early gains today in the first trading after the Spanish bailout and declined for a fourth day, sending the yield up 7 basis points to 5.84 percent.
“The scrutiny of Italy is high and certainly will not dissipate after the deal with Spain,” Nicola Marinelli, who oversees $153 million at Glendevon King Asset Management in London, said in an interview. “This bailout does not mean that Italy will be under attack, but it means that investors will pay attention to every bit of information before deciding to buy or to sell Italian bonds.”
Italy has 2 trillion euros of debt, more as a share of its economy than any advanced nation after Greece and Japan. The Treasury has to sell more than 35 billion euros of bonds and bills per month -- more than the annual output of each of the three smallest euro members, Cyprus, Estonia and Malta.
Spanish Economy Minister Luis de Guindos said on June 9 that he would request as much as 100 billion euros in emergency loans from the euro area to shore up a banking system hobbled by more than 180 billion euros of bad assets. Mounting concern about the state of Spain’s banks and public finances drove the country’s borrowing costs to near euro-era records last month, dragging up Italian rates in the process.
Investors initially appeared relieved by the news, with the euro gaining as much as 1 percent and the yield on Spain and Italy’s 10-year bonds falling 12 basis points and 15 basis points. Both gave up their gains.
“The problem for Italy is that where Spain goes, there’s always the perception that Italy could follow,” Nicholas Spiro, managing director at Spiro Sovereign Strategy in London, said in an interview. ’’There is insufficient differentiation within the financial markets. It is clear as the light of day and has been that Spain’s fundamentals are a lot direr than Italy’s. That hasn’t stopped Italy suffering from Spanish contagion.’’
Italy is on track to bring its budget deficit within the European Union limit of 3 percent of gross domestic product this year and the country is already running a surplus before interest payments, meaning its debt will soon peak at about 120 percent of GDP. The jobless rate is less than half of Spain’s 24 percent, and Italy didn’t suffer a real estate bust, leaving its banks healthy by southern European standards. The budget deficit was 3.9 percent of GDP last year, less than half that of Spain.
To be sure, a total debt more than twice Spain’s gives investors pause, especially in a country where economic growth has lagged the EU average for more than a decade. The euro region’s third-biggest economy, Italy is set to contract 1.7 percent this year, more than the 1.6 percent in Spain, the Organization for Economic Cooperation and Development estimates.
Italy’s debt load had traditionally led the country to be perceived as a bigger credit risk than Spain. At the start of this year, Italy’s 10-year bond yielded 202 basis points more than that of Spain. As the extent of Spain’s banking woes became more evident and the country was forced to raise its deficit target, that spread reversed and now Spain’s 10-year yields 44 points more than Italy’s.
That outperformance may offer little reassurance to investors as Italy’s 10-year yields still crept up to more than 6 percent last month, widening the gap with German bunds, the European benchmark, to 547 basis points on June 1.
Debt agency head Maria Cannata last week said that fewer foreign investors were turning up at Italian auctions in recent months and that the country could still finance at yields as high as 8 percent.
The exodus of foreign buyers has left the Treasury more dependent on Italian banks, which in turn have been among the biggest borrowers in the European Central Bank’s three-year lending operations. Italy returns to markets before Spain does, selling as much 6.5 billion euros of treasury bills on June 13, followed by a bond auction the next day.
“If Italy has a problem with accessing the markets because investors lose confidence in the Italian ability to do the right thing, the ECB will be drawn into the fire,” Thomas Mayer, an economic adviser to Deutsche Bank AG, said in a telephone interview. “That could pose a potentially lethal threat to European monetary union.”
Given the size of Italy’s debt, only the ECB has the firepower to rescue the country and yet deploying that ammunition -- through buying back bonds or making more long-term loans -- may prove unacceptable to Germany and its allies in northern Europe, Mayer said.
“The ECB will probably have to restart buying bonds but there will be a lot of sellers into that of people who are worried that Spain is the next Greece and Italy the next Spain,” said Lex Van Dam, who manages $500 million at Hampstead Capital LLC in London.
There may be little Italy can do on its own to protect itself. Monti, appointed by the president to succeed Silvio Berlusconi in November when Italy’s 10-year yield exceeded 7 percent, has implemented 20 billion euros of austerity measures, overhauled the pensions system and revamped the county’s labor markets and service industries.
Monti’s efforts helped shave more than 200 basis points off the 10-year yield by February, before the turmoil in Greece and Spain’s banking woes began driving up rates. Now with final passage of some of his reforms bogging down in parliament, Monti is pressing European allies to pivot from austerity to pro-growth policies.
“Mr. Monti seems to be infinitely more concerned about what’s going on abroad than what’s going on in parliament,” Spiro said. “Understandably so, because Italy has not been a master of its own fate for a long time. He’s perfectly aware that in order to fix Italy, they have to fix the euro zone.”