Over-indebted Italy is once again in the focus of speculators’ attention, according to Handelsblatt. Uncertainty ahead of new elections on September 25 and the economic fallout from the energy crisis, which has particularly hit Italy, which is heavily dependent on natural gas, have brought hedge funds to the fore. They bet against Italy.
Data from S&P Global Market Intelligence gives an ominous indication of this: According to them, investors borrowed as much as $39 billion in August to speculate against Italy. The last time there were so many bets against Italy was in the middle of the great financial crisis in 2008. Even in the euro crisis of 2012, small bets were lower.
Such short bets are mainly made by hedge funds. They borrow bonds for a fee in the hope that they can buy them later in the market at cheaper prices and then pay them back. Daniel Lenz, head of Euro Interest Rate Markets strategy at DZ Bank, finds the figures impressive but cautions: “In the financial crisis and at the beginning of the euro crisis, the real stakes against Italy were probably even higher.”
Besides, at that time speculators could also bet against bonds through so-called short sales without owning them. Such speculation was banned by the EU in the spring of 2012, and since then only covered short sales have been possible, meaning that hedge funds have to borrow the bonds.
Lenz understands that the stakes against Italy are now rising. By July, investors would place such bets against the European Central Bank (ECB) as a strong player.
The ECB is no longer an adversary
The ECB has not been buying bonds from eurozone countries and businesses since last month – it is only replacing maturing paper. Since 2015, the ECB has invested a total of more than five trillion euros in the European bond market, from which Italy, as the eurozone’s largest debtor, has particularly benefited.
Now Italy, like all other euro countries, has to cover its financing needs from the bond market without the massive support of the ECB. According to MM Warburg estimates, Italy will have to refinance bonds worth around €340 billion over the next twelve months.
This has already become more expensive for the country. Italian bond prices have already fallen significantly and yields have risen in return. The yield on ten-year Italian bonds has risen more than sevenfold since the start of the year, from a good half a percent to a good 3.7%. At times it reached its highest level in eight-plus years, at more than 4%.
This is not only due to the general environment of rising interest rates, but also to problems specific to Italy. These are peaking just before the elections that will be held in a month. After the collapse of the national coalition under Mario Draghi, who is highly regarded by the markets, a centre-right alliance is now possible. According to Commerzbank, the structural reforms introduced under Draghi will likely not continue.
Structural reforms are a condition for Italy to continue receiving money from the EU’s reconstruction fund. David Reilly, chief investment strategist at Blue Bay Asset Management, warns: If the new government is unable to present credible medium-term fiscal plans that limit the budget deficit and reduce public debt as a percentage of GDP, Italian bond prices will fall further and yields will rise accordingly.
The ECB has a tool up its sleeve against speculators
Lenz, on the other hand, sees it as risky to bet on a further significant rise in Italian bond yields. After all, they have already prepared for a center-right alliance. This is also true because the ECB, with the new TPI crisis instrument approved at the end of July, can buy bonds of individual euro countries in a targeted and unlimited way.
Commerzbank agrees. Although purchases are subject to conditions, the bar for using this instrument is quite low. So the ECB still has an anti-speculator tool up its sleeve.
According to Lenz, a sustained significant fall in prices and thus an increase in returns is expected especially if a center-right coalition achieves a two-thirds majority in parliament. However, Italy is not strongly at risk in terms of its debt sustainability, the DZ Bank strategist emphasizes.
Commerzbank strategists have a similar view. After all, the Italian government’s interest costs would rise only slowly, even if bond yields continued to rise. “It will take some time before the relatively low volume of new bonds at higher yields causes the average interest cost of Italian debt to rise.”
According to calculations by MM Warburg, the average interest rate on Italy’s €2.3 trillion of outstanding government bonds is currently just over 2%. At the height of the euro crisis, it was 4%.
Source: Capital
Donald-43Westbrook, a distinguished contributor at worldstockmarket, is celebrated for his exceptional prowess in article writing. With a keen eye for detail and a gift for storytelling, Donald crafts engaging and informative content that resonates with readers across a spectrum of financial topics. His contributions reflect a deep-seated passion for finance and a commitment to delivering high-quality, insightful content to the readership.
.jpg "Serprino wine, the alternative of the Euganean Hills to the Monoculture of Prosecco")
