Italy and Spain, which account for more than a quarter of the euro-area economy, are heading for sovereign bailouts in the next 12 months that will send shock waves through the global economy, Fidelity Investments’s Jamie Stuttard said.
Both sovereigns will likely stumble over debt auctions in the next year, forcing European authorities to find official funding for them to hold the single-currency area together, Stuttard, Fidelity’s head of international bond portfolio management in London, said in a telephone interview on June 19.
Southern Europe’s two major economies have 2.8 trillion euros ($3.6 trillion) of government debt, four times the total of Greece, Portugal and Ireland, threatening to overwhelm Europe’s crisis defenses. Backstopping them may undermine even Germany’s creditworthiness unless officials allow inflation to accelerate to reduce the real value of their borrowing or the currency weakens boosting exports, Stuttard said.
“We are onto the big countries now,” he said. “A rescue for Italy is pretty much impossible without a major change in German borrowing costs, a major change in overall euro-zone levels of inflation, a major change in the level of the euro, or a major change in the structure of the euro zone.”
Spanish bond yields jumped at an auction in Madrid today with the government paying 4.706 percent to borrow for two years, compared with 2.069 percent at a similar auction in March. Spain’s 10-year yields reached a euro-era record of 7.285 percent on June 18 while Italy’s benchmark yields surged to 6.342 percent on June 14, the most in about five months.
The analysis of economic historians such as Carmen Reinhart, Kenneth Rogoff and Niall Ferguson who have examined government finances over a longer period is more useful for understanding the debt crisis than the perspective of some market analysts who considered the first period of monetary union through 2007 as the norm, Stuttard said.
“This stuff defaults from time to time,” he said of government debt. “The idea that it’s risk-free is a relatively recent construct.”
Stuttard, who joined Fidelity last year from Schroder Investment Management Ltd., declined to comment on his holdings. He said he’s “extremely bearish” on the debt of peripheral governments. Fidelity is the biggest manager of U.S. 401(k) retirement plans and has about $1.6 trillion assets under management.
Italy and Spain will face about 1 trillion euros in principal and interest payments on their debts through 2014. European governments are capping fresh rescue lending at 500 billion euros once a permanent bailout fund comes into operation as planned in July after committing about 300 billion euros to Greece, Ireland and Portugal.
The International Monetary Fund announced this week it has additional funding commitments of $456 billion giving it $836 billion for lending worldwide. That leaves the pot about 300 billion euros short if Italy and Spain need aid, Julian Callow, head of international economics at Barclays, said in a June 19 e-mail. Spain’s government said June 9 it plans draw as much as 100 billion euros in EU funds to rebuild its banks.
“This is the biggest crisis with which the IMF has ever had to deal,” Massachusetts Institute of Technology Professor Simon Johnson, a former IMF chief economist, said in an e-mail. “It’s the entire euro zone that is now in crisis -- about a quarter of the world economy.”
Italian Prime Minister Mario Monti and his Spanish counterpart Mariano Rajoy are urging German Chancellor Angela Merkel to allow them to issue bonds backed by all 17 members of the single currency area in order to place their borrowing costs on a more sustainable footing. Rajoy also called on the European Central Bank to buy Spanish bonds to lower the nation’s borrowing costs.
Merkel said on June 3 that “under no circumstances” would she agree to have Germany back so-called euro bonds, while French President Francois Hollande has endorsed the plan. Germany’s benchmark borrowing costs have jumped 32 basis points this month after reaching the lowest level since reunification on June 1.
“How the various different problems are resolved over the next six to 12 months will have big ramifications for Germany and France, but also the U.K. and indeed the world,” Stuttard said.