Blog

13/6/2018 – Article published previously in the blog “USA. And Emerging Markets “of CincoDías.com

The political crisis in Italy is shaking the financial markets. The suggestion of the Five Star Movement and the Northern League of wanting to leave the euro has shaken the minds and hearts of investors this June 2018.

Financial markets do not like uncertainty. Thanks to the politicians of Italy, in recent days they have had a lot of insecurity. The previous month, May, the stock markets had been mired in turmoil for days, while there were squabbles between the ruling populists and the country’s president, who had rejected the election of the winning election parties of a skeptical euro economist like finance Minister. In the end, the politicians have reassured the markets and these, in turn, have returned to calm … “chicha” … As always, in Italy.

Italy lives in a state of slow economic growth and its public debt of 2.3 trillion euros equals 132% of GDP. The drama again raised concerns (temporarily shelved) about those two serious problems and the deep fear that the third largest member of the euro zone could be sneaking out, as happened to Greece since 2010. The returns of 10-year bonds increased, albeit less dramatically than on previous occasions. The yields of the German Bunds, the safest government bonds in Europe, decreased.

The prices of the shares fell. Banks in Italy, holders of government bonds amounting to 600,000 million euros, were the most affected. UniCredit, the largest financial institution in the country, fell 9.2% on the stock exchange and Intesa Sanpaolo, number two, lost 7.2% of its value between May 28 and 29. The shares of other European banks were also beaten. Concerns spread across the Atlantic. The S & P 500 index fell 1.2% on May 29, and the banks again led the decline. The yield on 10-year Treasury bonds fell from 2.93% to 2.77%, the biggest drop since the day after the British voted in favor of Brexit in June 2016.

The yield on Italy’s two-year bonds is below the 7.6% reached in November 2011, in the depths of the previous crisis in the euro zone. Before we had already begun to suffer the effects of the American financial and economic crisis (2007-2009) and the subsequent European economic recession that led to a strong debt crisis. The negative financial effect on the euro area and the euro’s own problems reached the highest level this year, on May 29.

It is also unlikely that foreigners have suffered from falling bond prices (the corollary of increased yields). Italy’s huge public debt market gives it a decent weight in the global bond indexes: foreign investors, seeing them coming, had reduced positions in advance. Financial analysts estimate that the exposure of banks outside Italy has fallen by almost half since 2009, to 133 trillion euros.

The escalation of yields has not yet threatened the sustainability of Italy’s debt. On May 30, Italy sold a total of 5,600 million euros in five, seven and ten year bonds, with yields of 2.32%, 2% and 3%, respectively. The average coupon of 3.4% on the stock of existing debt. And, with respect to the longer average maturity of Italian bonds, analysts estimate yields of at least 4-4.5% for several months, before coupon payments are higher, which could make the debt unbearable. It seems unimaginable, but we already saw what happened in Greece or in Iceland.

That possibility is one of the reasons for the European Central Bank (ECB), which, logically, is a nightmare for Italian populists. In the framework of its quantitative easing program, the ECB bought Italian bonds worth 340,000 million euros. In effect, he has been a willing buyer since foreigners have resigned.

For the United States, or for the populist government that undid the recent reforms of the governments of Romano Prodi, Mario Monti, Enrico Letta and Matteo Renzi, the doors of the treasury were opened and other governments accepted the benevolence of Brussels or Frankfurt (that is, Berlin or, what is the same, Angela Merkel, whose patience seems to have a limit). The eternal problem of the Italian banks is that – as, for example, it happens to Monte dei Paschi di Siena – they are still in the ICU. The burden of bad loans, although reduced, remains heavy.

The departure from the euro area would be unthinkably expensive for both Italy and the eurozone. As when Argentina was abandoned in early 2002, the value of Italian bank deposits would plummet. Italy is not Greece (thank God), at that point Italy is much better. But it is not Greece either, because the Italian economy is much bigger than the Greek one, which makes it dangerous for the rest of the countries in the euro zone.

In 2012, Mario Draghi, the president of the ECB, repressed the crisis that seemed likely to destroy the currency club, saying that the ECB could make “direct monetary transactions.” But this hardly gives Italy a free pass. What Draghi announced is intended for extreme circumstances. Matteo Renzi had negotiated an agreement with the European institutions: help in exchange for reforms. His government did not last long. Greece has been working under a similar regime, but much worse because the Troika controls the Greeks to the number of glasses of water they drink daily.

It seems unlikely that the populists in Italy (Northern League, far right, Five Star Movement, extreme left) will volunteer to Brussels for help.