Is the endgame near for Italy?
Interest rates on Italian bonds rose to euro-era records on Monday, close to the level that have forced Greece, Ireland and Portugal to seek financial rescues.
Most economists do not expect Italy to plead for a bailout yet. Instead, they say they think the higher rates will force the European Central Bank or other European neighbors to intervene more forcefully with measures to push down rates.
The yields on Italy’s 10-year bonds, a measure of investor anxiety about lending money to the country, rose to 6.63 percent at one point during trading on Monday. Five-year yields were even higher, at 6.65 percent, up half a percentage point on the day. The two-year yield also rose, to 5.9 percent.
Economists and investors say the dynamic is worrying. They fear the higher rates may incite bond clearing houses — the middlemen between buyers and sellers of the bonds — to demand higher collateral payments from traders of Italian debt. That, in turn, could lead to a further damaging spike in interest rates. Higher rates also threaten to sap Italy’s long-term ability to support its debt load, nearly 120 percent of its annual economic output at the end of last year, which is among the highest for countries that use the euro currency.
“This is feeding on itself,” said Eric Green, an economist at TD Securities. “It continues to put pressure on Italy.”
Bond rates are being driven by investors’ doubts that Prime Minister Silvio Berlusconi of Italy can push through sweeping changes to improve economic growth, including making pensions less generous and selling off some of the country’s assets. The measures are widely considered necessary to tackle Italy’s heavy debt load and revive its stagnating economy.
Investors are also selling Italian bonds because they fear that other European countries will not provide billions of euros to support Italy if conditions deteriorate even more.
They worry that European leaders have not come up with sufficient details about an expanded bailout fund, which is meant to provide ample firepower for Italy and other countries, like Spain, should the markets turn against them.
“Euro zone policy makers have yet to announce a policy bazooka,” Jens Nordvig, an economist at Nomura Holdings in New York, said in a research note. He said the structure of a purported $1.4 trillion bailout fund, announced at a meeting of European leaders in Brussels last month, “is insufficient to provide a credible backstop.”
Italy’s interest rates rose early Monday, then fell back slightly as rumors spread through the markets that Mr. Berlusconi was intending to step down, although they rose again later in New York trading.
Mr. Berlusconi denied the speculation that he was leaving office. Yet the markets seemed to say that investors would be happier about Italy’s future if he yielded power.
“The government needs to do a lot more to gain the full confidence of the Italian people, external creditors and the markets,” said Mohamed El-Erian, chief executive of the bond giant Pimco.
Andrea Schlaepfer, a spokeswoman for LCH.Clearnet, the big European clearing house that trades in bonds, said the spread between the yield on Italian bonds and the yield on a basket of AAA-rated bonds is one factor the company would consider before deciding to raise collateral requirements. Other factors include rates on credit default swaps.
The credit default swap rates that measure the cost of insuring Italian debt against default rose to near-record highs on Monday. It now costs $511,000 a year to insure $10 million in Italian debt for five years, according to the data provider Markit, compared with $145,000 in June.
The higher interest rates present hurdles for issuing new debt. Italy’s next auction of debt is on Nov. 14. It must raise 30.5 billion euros in November, and another 22.5 billion euros in December, according to Daiwa Securities.
When its interest rates were just above 6 percent, Daiwa estimated, the extra bond yields were already adding as much as 3 billion euros a year in additional interest payments compared with around 4.5 percent, the rate as recently as the summer.
Now those debt costs are rising with every basis point increase in bond yields.
The climbing yields could present a worrying spiral that, before Italy, affected Greece, Ireland and Portugal. When rates for those countries’ bonds reached around 7 percent, they suddenly jumped even higher and have still not come down to more sustainable levels.
Italy, the euro zone’s third-largest economy after Germany and France, is on a different scale than those much-smaller nations.
Italy is also, in a way, in a healthier situation. Although its debt mountain is large, it is actually running a primary budget surplus, which means that its budget is running a surplus before debt service costs.
According to Mr. Green of TD Securities, this means Italy could survive paying rates close to 7 percent for some time — but not forever. Eventually, the higher rates would worsen economic growth, and as the economy contracted, a wider and wider deficit would begin to open up.
Before Italy is forced to seek assistance from the European Union or the International Monetary Fund, economists say, the rising rates will force the European Central Bank to increase its purchases of Italian debt in secondary markets, which began in August.
Because the central bank bond purchases have failed to keep Italian interest rates down, economists expect that the bank will soon have to act much more aggressively.
Mr. Green said the design of the bailout package announced last month might, in fact, have encouraged investors to sell Italian bonds. The new fund may only protect holders of newly issued Italian bonds, which reduces investors’ incentives to hold existing securities.
The deal to allow Greece to write off 50 percent of its debts to private investors without setting off credit default insurance protection has also left many investors feeling vulnerable, encouraging them to sell now.
Article source: http://feeds.nytimes.com/click.phdo?i=4e72a1f62e732d27f1212933e1df6250
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