Friday, October 28, 2011

Worrying Signs

I don't like seeing stories like this just a day after the eurozone's latest and greatest rescue plan was announced:
Italian borrowing costs surge in lacklustre auction

Italy issued 10-year debt on Friday but paid the highest price since joining the euro as investors demonstrated scepticism over the centre-right government’s economic reform programme in the first bond auction in the region since new steps were agreed to tackle the eurozone debt crisis.

...The yield on Italy’s March 2022 bond rose to 6.06 per cent from 5.86 per cent a month ago. The sale of the 10-year bonds was covered less than 1.3 times, but demand for the total sale of medium and long-term paper was sufficient for the Treasury to raise €7.94bn – at the top end of its target range. The yield on a three-year debt maturing in July 2014 rose to 4.93 per cent, at its highest since November 2000, compared to 4.68 per cent at an end-September sale.

“All in all, today’s auction was not very satisfying,” said Annalisa Piazza at Newedge Strategy. “Although the EU summit welcomed the new measures the Italian government is planning to implement in the next eight months to ‘change’ the economy, markets remain sceptical about the outcome.”

Officials recognise that yields at this level are unsustainable in the long term with Italy needing to roll over more than €250bn next year to finance its €1,900bn debt burden amounting to 120 per cent of gross domestic product...
Meanwhile, the ECB has apparently been forced to buy up more Italian debt on the secondary market since the new eurozone rescue plan was announced. But because of the ECB's obvious reluctance and the backwards way that they've structured their bond-buying program, such purchases probably have very little effect, other than to reinforce market skepticism about Italian debt.

I've argued repeatedly that the ECB can and should assume full responsibility for ending this crisis, and that it should be targeting interest rates on the secondary markets for Spanish and Italian debts. Paul De Grauwe articulates this reasoning perfectly in a column this week, and more generally expresses how painful it is to watch the ECB make mistake after mistake:
There is no sillier way to implement a bond purchase programme than the ECB way. By making it clear from the beginning that it does not trust its own programme, the ECB guaranteed its failure. By signalling that it distrusted the bonds it was buying, it also signalled to investors that they should distrust these too.

Surely once the ECB decided to buy government bonds, there was a better way to run the programme. The ECB should have announced that it was fully committed to using all its firepower to buy government bonds and that it would not allow the bond prices to drop below a given level. In doing so, it would create confidence. Investors know that the ECB has superior firepower, and when they get convinced that the ECB will not hesitate to use it, they will be holding on to their bonds. The beauty of this result is that the ECB won’t have to buy many bonds.
I am not impressed by the direction in which things have been heading in Europe this week. My sense is that, like me, many financial market participants have been suffering from so much 'crisis exhaustion' that they were willing to give this week's rescue package the benefit of the doubt and believe that it was in fact sufficient to permanently put things on a stable footing. Everyone wants this crisis to be over. But the inadequacies of the plan are real, and will only become more apparent over time. I hate to say it, but I fear that we haven't reached the final fix yet.


  1. Chris Marquesas11:43 AM

    Krugman agrees. Read his "Here We Go Again" piece today.

  2. debitofilo10:30 AM

    what is really worring is this
    Italy Govt Bonds 2 Year Gross Yield <span>4.750</span>

    we have rolled 300 bln year on year for 10 years now we have problems


  3. Anonymous8:59 PM

    "many financial market participants . . . were willing to give this week's rescue package the benefit of the doubt and believe that it was in fact sufficient to permanently put things on a stable footing."

    There are certainly plenty of idiots in the markets -- but not THAT many. I think it's more a case that the momentum players have concluded that the latest deal pushes the crisis into 2012, which is beyond their quarterly trading horizon. So it's time to go long again. And the momentum players are the marginal buyers.

    Just another example of how markets can be individually rational and collectively insane.

  4. Henry Kaspar10:44 PM

    The alterantive explanation is that Italy's government does its best to convince everybody that it is insolvent - in which cae no liquidity scheme on earth, no matter how large, glittery or how well presented, could help.

    One would think that weak demand for Italian bonds only one day after Eurore has tripled the amount of funds available to support Italian (and other) debt would make some reconsider that this is all only about liqudity (and the ECB's reluctance to provide it unconditionally).

  5. Kosta Vasilakos6:06 AM

    Perhaps this move in Italian interet rates in October reflects an improvement in the global economy, or even global markets, that's been partially reflected in a 15+ % increase in the North American stock markets?

    Yes, the yield on Italian debt is up, but so is the yield on German debt.  The spread between the two closed at 385 bp, which is below the highs of 400 of both October and September

    Perhaps we should watch for a few more days before calling the latest European rescue effort a failure?

  6. who's subscribing to italian bonds (other than ECB)?

  7. If the Ecb "fixes" PIIGS spreads it would fall into a political minefield. It should determine, for example, that Portuguese bonds should carry a higher spread that Italian bonds. This opens the way to a political storm in these countries ("we are being shortchanged even if our fundamentals are better"). THe Ecb  doesnt want to go there. 

  8. <span>And while there is one US t bond, there are a lot of competing 10-year euro bonds. This means demand is more elastic...which means that fixing PIIGS spread would require a massive amount of buying from the ECB...which could in the end mean that the ECB is the main creditor of several PIIGSs. Which bring us back to the question of credibility.</span>

    Add the problem of private debt, where spreads could very well very high for Piigs debtors, even if the state bond market is fixed..

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