Italy Tests Appetite for Debt When ECB Is Absent: Euro Credit
Italy Tests Appetite for Debt When ECB Is Absent
Alessandra Benedetti/Bloomberg
The Italian national flag, left, and the European Union flag hang on flagpoles outside the Italian economy and finance ministry, in Rome, Italy.
The Italian national flag, left, and the European Union flag hang on flagpoles outside the Italian economy and finance ministry, in Rome, Italy. Photographer: Alessandra Benedetti/Bloomberg
Aug. 29 (Bloomberg) -- Luca Cazzulani, a senior fixed-income strategist at UniCredit Global Research, discusses the outlook for Italy's bond auction tomorrow. Cazzulani, speaking from Milan with Maryam Nemazee on Bloomberg Television's "The Pulse," also talks about the performance of U.S. Treasuries and the outlook for Federal Reserve monetary policy. (Source: Bloomberg)
Aug. 29 (Bloomberg) -- Florent Combes, head of fixed income at Ecofi Investissements, discusses the European sovereign debt crisis and bank capital. He speaks from Paris with Owen Thomas on Bloomberg Television's "Countdown." (Source: Bloomberg)
Templeton Asset Management's Mark Mobius
Jerome Favre/Bloomberg
Mark Mobius, executive chairman of Templeton Asset Management's emerging markets group.
Mark Mobius, executive chairman of Templeton Asset Management's emerging markets group. Photographer: Jerome Favre/Bloomberg
Italy will attempt to raise money in the bond market this week without the safety net of buying by the European Central Bank, which has restrained the nation’s borrowing costs for three weeks by buying its debt.
The euro’s founding treaty bars the central bank from buying bonds directly from governments, meaning it can only provide secondary market support. As well as 3.75 billion euros ($5.4 billion) of 10-year securities to create a new benchmark, Italy is marketing 4.25 billion euros of bonds maturing in 2014 and 2018, with Spain and France also planning sales.
“This is where the litmus test comes, the test to see whether the ECB’s buying power can hold yields where they are,” said Shahid Ikram, head of sovereigns at London-based Aviva Investors, which has some of its $440 billion of assets invested in Italian bonds. “From a risk-return perspective, there’s a great deal of uncertainty. You are going to see more volatility in the Italian yield, some concession will be required and then it’s just a case of what real demand there is.”
The ECB began buying Spanish and Italian government bonds on Aug. 8 to stop the debt crisis from spreading to the euro- region’s third- and fourth-biggest economies. The purchases brought the nations’ 10-year bond yields down to about 5 percent from euro-era records, even as Europe’s leaders disagreed over how to contain the turmoil.
‘Huge Volatility’
Italian 10-year bonds yielded 5.09 percent, after reaching a euro-era record 6.40 percent on Aug. 5 and sliding more than one percentage point to 5.02 percent in the five trading days after the ECB began buying. Both Aviva’s Ikram and Werner Fey, a fund manager at Frankfurt Trust Investment GmbH in Frankfurt, which oversees about 6.5 billion euros of fixed-income assets, said they won’t be buying at this Italian auction.
“The problem for fund managers is that there is huge volatility and big event risk,” Fey said. “The politicians are not coming up with a solution. There’s a risk the ECB may end its program and there will be a massive hit on Italian paper. You cannot exclude that the market will test the Italian bond yield highs again.”
At the most recent auction on July 28, the 10-year yield demanded by investors climbed to 5.77 percent from 4.94 percent a month earlier. That compares with 4.73 percent at a May 30 sale, while the average yield at three auctions prior to May was 4.83 percent, according to Bloomberg data.
Auction Demand
Demand at tomorrow’s auctions should be good, said Luca Cazzulani, a senior fixed-income strategist at UniCredit Global Research in Milan, because the amount on offer is low compared with other initial sales and domestic buyers have continued to buy at previous auctions, even in times of market stress.
Italy had 1.6 trillion euros of debt at the end of last year, according to its debt management office, making it Europe’s biggest national bond market. The ECB may have to buy as much as 5 percent of outstanding debt over about 30 weeks to keep borrowing costs at 5 percent, according Kornelius Purps, a strategist at UniCredit SpA in Munich.
When the central bank began its bond program on May 10, 2010 -- buying 16.5 billion euros of government securities in a bid to support the Greek market -- Greece’s 10-year bond yields fell more than 4.5 percentage points to 7.77 percent. Ten weeks later, as the ECB’s spending dwindled to 176 million euros, Greek bond yields climbed to 10.43 percent. They reached as much as 18.18 percent today.
ECB Support
The bond-buying program didn’t provide enough support to prevent Ireland and Portugal following Greece in requesting financial aid. Ireland’s 10-year yields fell to 4.72 percent on May 10, 2010, the day the ECB began buying, from 5.86 percent the previous trading day. They had climbed to 8.9 percent by Nov. 11, the week before the nation requested aid.
Portugal requested a bailout on April 6 this year as its 10-year yields surpassed 8 percent even after the ECB had spent 77 billion euros on government debt. Its yields climbed to a record 13.44 percent on July 11 as the central bank took a five- month pause from bond buying.
“The risk is that the ECB stays out of the market, yield spreads widen significantly and then trading out of Italy is a challenge,” said David Schnautz, a fixed-income strategist at Commerzbank AG in London. “There’s a decent risk that investors will have to buckle up for a yield increase above 6 percent.”
Deficit Measures
ECB President Jean-Claude Trichet wrote to Italian Prime Minister Silvio Berlusconi demanding more deficit measures in return for buying the country’s bonds. To win ECB support, Italian politicians approved the second austerity package in a month on Aug. 12, aiming to balance the budget in 2013.
That’s a tall order, said Eric Wand, a bond strategist at Lloyds Bank Corporate Markets in London, because the global economic outlook is deteriorating. Italy’s debt stands at about 120 percent of its gross domestic product, the biggest ratio in Europe after Greece, whose fiscal woes sparked the sovereign crisis.
Buying bonds is “the last thing the ECB wants to be doing,” Wand said. “Politicians don’t seem to be able to get ahead of the market so the ECB is the last plug in the hole. Italy needs further structural reform as well as austerity measures to bring down borrowing costs.”
Investors willing to bet Italy can tame its budget deficit and win back market confidence while the central bank props up its bond market may be able to profit in the short-term, Frankfurt-Trust’s Fey said, because they have the chance to earn a premium over German bunds, the euro-region benchmark.
The yield difference, or spread, between Italian 10-year securities and similar-maturity German bunds is about 2.9 percentage points, compared with a five-year average of about 0.9 points.
“If you believe that the ECB will be able and willing to keep up the support then this is a fantastic bond to buy,” said Luca Jellinek, London-based head of European rate strategy at Credit Agricole Corporate & Investment Bank. “There’s no reason to believe that the ECB lacks resolve, but it’s risky. It’s a guess.”
To contact the reporters on this story: Emma Charlton in London at echarlton1@bloomberg.net; Keith Jenkins in London at kjenkins3@bloomberg.net
To contact the editor responsible for this story: Mark Gilbert at magilbert@bloomberg.net
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