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The Big Domino -- Italian 10-year Bond Yield Passes 7%

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  • The Big Domino -- Italian 10-year Bond Yield Passes 7%

    This looks like "the" tipping point to me. What do you all think? Can this still be contained?

    From the Telegraph:
    Once above the 7pc mark, Greece lasted just 13 days before requesting a bail-out. Ireland lasted 15 days. Portugual held out longer but succombed after 49 days.

    How long Italy can last is now the big question. The debt pile is far bigger. But Italy's economy is stronger.

    It has a primary budget surplus for starters - if you exclude interest payments, Italy collects more in tax than it spends.

    The country also has enormously valuable assets - the state property portfolio would easily cover the nation's debts, according to bankers. This can't be marshalled over night - or without a political fight, as Greece's asset-sale programme has shown.

    In the meantime, the eurozone simply doesn't have the firepower in place to bail-out Italy. That's the problem.

    The yield was at 7.25% the last time I checked.

    Italian 10-year Bond Yield

  • #2
    Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

    This blogger at The Economist feels the same way I do:
    I have been examining and re-examining the situation, trying to find the potential happy ending. It isn't there. The euro zone is in a death spiral. Markets are abandoning the periphery, including Italy, which is the world's 8th largest economy and 3rd largest bond market. This is triggering margin calls and leading banks to pull credit from the European market. This, in turn, is damaging the European economy, which is already being squeezed by the austerity programmes adopted in every large euro-zone economy. A weakening economy will damage revenues, undermining efforts at fiscal consolidation, further driving away investors and potentially triggering more austerity. The cycle will continue until something breaks. Eventually, one economy or another will face a true bank run and severe capital flight and will be forced to adopt capital controls. At that point, it will effectively be out of the euro area. What happens next isn't clear, but it's unlikely to be pretty.

    ...

    I hate to get this pessimistic about the situation. It feels panicky and overwrought. I can't believe that Europe would allow so damaging an outcome as a financial collapse and break-up to occur. And I still don't understand why, if this is all as obvious as it seems to me, equities aren't down 20% now, rather than 2% or 3%. But the window within which something could be done to prevent it is closing, and fast. I hope to be proven astoundingly wrong in my assessment, but I'm struggling to see alternative outcomes.

    What am I missing? What is the unrealistic part of this assessment? In short, why no panic at this development?

    Comment


    • #3
      Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

      Well at least it is poetic. Domino is a word of Latin origin.

      Comment


      • #4
        Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

        Originally posted by ASH View Post
        This blogger at The Economist feels the same way I do:
        I have been examining and re-examining the situation, trying to find the potential happy ending. It isn't there. The euro zone is in a death spiral. Markets are abandoning the periphery, including Italy, which is the world's 8th largest economy and 3rd largest bond market. This is triggering margin calls and leading banks to pull credit from the European market. This, in turn, is damaging the European economy, which is already being squeezed by the austerity programmes adopted in every large euro-zone economy. A weakening economy will damage revenues, undermining efforts at fiscal consolidation, further driving away investors and potentially triggering more austerity. The cycle will continue until something breaks. Eventually, one economy or another will face a true bank run and severe capital flight and will be forced to adopt capital controls. At that point, it will effectively be out of the euro area. What happens next isn't clear, but it's unlikely to be pretty.

        ...

        I hate to get this pessimistic about the situation. It feels panicky and overwrought. I can't believe that Europe would allow so damaging an outcome as a financial collapse and break-up to occur. And I still don't understand why, if this is all as obvious as it seems to me, equities aren't down 20% now, rather than 2% or 3%. But the window within which something could be done to prevent it is closing, and fast. I hope to be proven astoundingly wrong in my assessment, but I'm struggling to see alternative outcomes.

        What am I missing? What is the unrealistic part of this assessment? In short, why no panic at this development?
        I have read today (sorry, don't remember where) that markets don't plunge because they are 100% sure that the european leaders (Merkel, Sarkozy and the eurocracy) will do whatever is necessary to prevent a european catastrophe.

        Comment


        • #5
          Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

          "The country also has enormously valuable assets - the state property portfolio would easily cover the nation's debts, according to bankers."

          That is what they want; however, even though new economic theory will call this rotating capital, its not capital but land rents. It will put another tax on Italy, raising the cost of production. "Hot money" cannot expand what cannot be expanded. The marginal return on investment is less than zero. You don't get more widgets, you get a more expensive Colosseum and more fat, retired bankers.

          Comment


          • #6
            Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

            Originally posted by Alvaro Spain View Post
            I have read today (sorry, don't remember where) that markets don't plunge because they are 100% sure that the european leaders (Merkel, Sarkozy and the eurocracy) will do whatever is necessary to prevent a european catastrophe.
            That makes sense. If one's choice is between a total catastrophe versus painful political concessions, then the painful concessions are the rational choice. I must be suffering from a deficit of confidence in the European leadership... something less than 100% certainty.

            Comment


            • #7
              Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

              Originally posted by Alvaro Spain View Post
              I have read today (sorry, don't remember where) that markets don't plunge because they are 100% sure that the european leaders (Merkel, Sarkozy and the eurocracy) will do whatever is necessary to prevent a european catastrophe.

              As the crisis intensifies the liklihood of catastrophe increases but so does the liklihood that politicians will overcome their paralysis and do something dramatic. Or that politicians will remain paralyzed but the ECB will do something dramatic. That's the conundrum for the markets.

              Comment


              • #8
                Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

                Originally posted by ASH View Post
                What am I missing? What is the unrealistic part of this assessment? In short, why no panic at this development?
                The ECB can come in at a moments notice and start printing Euros to stabilize the situation. The question is, will they?

                http://http://www.creditwritedowns.c...etisation.html

                Comment


                • #9
                  Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

                  ZH is pointing to a reuters article where speculation of a "core" euro addressed...

                  http://www.reuters.com/article/2011/...7A85VV20111109

                  maybe this is the only way EUR can be saved, if saving is even the right term for this?

                  Comment


                  • #10
                    Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

                    Originally posted by ASH View Post

                    What am I missing? What is the unrealistic part of this assessment? In short, why no panic at this development?
                    Look at TED spread in link below only under 5 year chart. Then look to left to year 2007 when spread approaches 100. One year later market collapse. I dont know why it takes this long for positions to unwind but this is one scenario that has played out before


                    http://www.bloomberg.com/apps/quote?ticker=.TEDSP:IND

                    Comment


                    • #11
                      Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

                      Originally posted by ASH View Post
                      That makes sense. If one's choice is between a total catastrophe versus painful political concessions, then the painful concessions are the rational choice. I must be suffering from a deficit of confidence in the European leadership... something less than 100% certainty.
                      Of course, if politicians start to believe that catastrophe is certain, then their attention will switch back to protecting their own interests.

                      The Greeks have again failed to agree on a government, will resume talks tomorrow. And of course, while Italy plummets into the abyss Berlusconi can at least congratulate himself on retaining immunity from prosecution for another day.

                      Comment


                      • #12
                        Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

                        Meanwhile the 10-year T-note drops to below 2%. Strange times. [SARC]Looks like that US downgrade was warranted.[/SARC]

                        The shoe will have to drop. Politics cannot move as fast as markets. The big fall should happen before next summer. When? That's anyone's guess.

                        Comment


                        • #13
                          Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

                          I've been thinking that the dynamic in Europe is very close to what EJ warned about with respect to America's debt and its output gap. EJ said that if the US tipped into recession before it could close its output gap, while continuing to run big deficits, the debt dynamics would get out of hand. Now we have a nascent European recession and weak growth threatening the credit of otherwise solvent core European states like Italy and France, leaving no scope for fiscal stimulus.

                          Comment


                          • #14
                            Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

                            Originally posted by we_are_toast View Post
                            The ECB can come in at a moments notice and start printing Euros to stabilize the situation. The question is, will they?

                            http://http://www.creditwritedowns.c...etisation.html
                            the real question becomes, eventually how can they not?

                            an independent Germany would have a hard time competing with too strong a currency on it's own. The fabled French lifestyle would die if France had to stand on it's own. Belgium is not so good by itself, and we all know the story of the PIIGS.

                            Everyone gets hurt in a break up except... those who abandon their debts and screw everyone in the process. Since the kleptocrats control "da players", eventually the rescue has to come...

                            Comment


                            • #15
                              Re: The Big Domino -- Italian 10-year Bond Yield Passes 7%

                              Originally posted by we_are_toast View Post
                              The ECB can come in at a moments notice and start printing Euros to stabilize the situation. The question is, will they?

                              http://http://www.creditwritedowns.c...etisation.html
                              The ECB was already buying Italian bonds today, but not enough to keep the yield below 7%. As the blogger from The Economist mentioned, it would probably take an explicit statement of policy rather than behind the scenes purchases to reverse this. And the ECB doesn't have a legal mandate to do so. That said, it's just possible that Mario Draghi might step off the reservation, exceed his mandate, and then dare the Germans to do something about it. However, there's some thought that the ECB has less capacity to intervene than comparable central banks because it isn't backed explicitly by a unified national treasury. Recognizing that this article is written by someone who doesn't think the euro was a good idea, it's worth considering:
                              The Bank of England and the US Federal Reserve have explicit guarantees from national treasuries that any losses stemming from bond purchases will be compensated, giving them the "credibility halo" of sovereign states.

                              The picture is entirely different in Euroland where the ECB has very little money of its own and shares key powers with the national central banks. There is no fiscal union to back up monetary union, and no sovereign entity underpinning the project. There is instead a Babel of conflicting sovereign voices.

                              The ECB's paper losses are already becoming an issue. Simon Ward from Henderson Global Investors said the ECB system has accumulated almost €200bn in Greek exposure alone. The bank holds an estimated €45bn of Greek bonds. As of late August, it had provided €110bn in support to Greek banks through its normal lending window as well as through "emergency liquidity assistance" (ELA) against weak collateral. This bank support may since have mushroomed to €150bn.

                              Mr Ward said it is unclear whether the ECB has taken on similar sorts of "back-door" ELA liabilities in Italy and Spain because the data has been delayed. The stated level of ECB intervention is €587bn for eurozone banks and €184bn in bond purchases. "We think there is a lot more going on quietly," he said.

                              Hans-Werner Sinn from Germany's IfO Institute said the Bundesbank's exposure to eurozone liabilities through so-called "TARGET" credit has ballooned to €450bn, with the Banca D'Italia making the biggest demands by far in September. In effect, this is a lending operation by the Bundesbank to EMU's weaker central banks. Dr Sinn said it is "not legally clear" what happens if any country defaults or leaves EMU.

                              Kenneth Rogoff, a Harvard professor and the IMF's former chief economist, said the ECB may have to "going crawling on hands and knees" to eurozone governments for more money. "If the ECB has bought a lot of junk debt and lost money it will have to asked to be recapitalised," he said. "Ultimately, Europe will have to change the whole constitutional structure of the eurozone, because this crisis is not a temporary liquidity problem."

                              Another pessimistic take on the prospect for big ECB intervention, by the same blogger at The Economist, is here:
                              In theory, the ECB could short circuit the rising yields/insolvency feedback loop by promising to buy Italian and Spanish bonds, thereby giving those countries breathing space to enact their fiscal consolidation plans. The ECB might not even need to spend money; a credible commitment could convince the bond market that resistance is futile, driving down yields on its own. Or so the argument goes.

                              I'm sceptical. The expectations game only works if you can make a credible promise. But the ECB’s limited bond buying has already generated tremendous dissent, and a more aggressive backstop would face even greater internal resistance, political opposition and legal challenges. Given these obvious constraints, why would investors believe that the ECB could sustain a more ambitious commitment?

                              Of course, a change in ECB policy could be accompanied by an initial show of force in the market. But the ECB’s resolve would be continually tested. What would happen if the ECB backed Italian debt but the country showed no sign of realigning its finances? Would investors blink first in a test of wills?

                              I doubt it—investors will expect Germany to put the breaks on a full-fledged debt guarantee at some point. The difference between the ECB and the Bank of England or the Fed isn’t just a matter of official mandates; unlike the ECB, the latter represent a cohesive democratic polity, with sufficient social and political unity necessary to sustain a lender-of-last-resort commitment.

                              Moreover, Italy and Spain don’t just face a "panic premium" akin to bank run; they face very real solvency questions. The ECB's intervention wouldn’t address these underlying problems (except insofar as interest payments contribute to the solvency challenge) and might, in fact, discentivise necessary reform by alleviating market pressure.

                              And if the ECB were to back Italian debt only to discover that, lo and behold, the peninsula is insolvent, the consequences would be disastrous. The ECB has roughly €82 billion in capital and reserves. In the event of a euro sovereign default, the ECB would need to be bailed out by euro states (i.e. backdoor euro bonds) or print its way out of trouble. Either course of action would be massively unpopular, institutionally destabilising and possibly illegal.
                              Last edited by ASH; November 09, 2011, 03:01 PM.

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