Thursday, June 27, 2013

Italy and the new pressure on the eurozone

It's looking like "game on!" again for the euro crisis, which has been smoldering and stumbling along for the last year with little progress but no acute outbreaks. Matthew Boesler reports in The ECB Scheme That Saved Europe From Disaster Last Summer Is Practically Dead Business Insider 06/26/2013 that the US Federal Reserve's recent misguided decision to raise interest rates is impacting the eurozone in a serious way. (Paul Krugman explains why that was a bad idea in domestic US terms in Et Tu, Bernanke? New York Times 06/23/2013.)

Boesler explains:

"Liquidity-driven markets have just been presented with the antithesis of ECB president Mario Draghi's July 2012 pledge to 'do whatever it takes' to save the eurozone," says Nicholas Spiro, managing director of Spiro Sovereign Strategy. "Perceptions of the Fed's policy actions, as opposed to those of the ECB, are now shaping sentiment towards eurozone peripheral debt."

That, of course, presents a bit of a problem for eurozone policymakers, who for years now have been engaged in attempts to remedy longstanding structural defects in the common currency and, by extension, the euro crisis itself. And since the ECB's introduction of OMT in September, against a backdrop of rising stock markets and falling bond yields, eurozone policymakers have had a pretty nice work environment in which to move forward with complicated integration plans.

Now, "the calm has given way to mild panic," says Spiro. "It's one thing for eurozone leaders to disagree about how to shore up the bloc when market conditions remain benign, but quite another when investors are running scared."

In a note to clients on Sunday, Morgan Stanley's Fels put it thus: "Things haven’t exactly gone well recently: the global market rout has pushed up bond yields in the periphery, political risk is back in Greece, where the government coalition was dealt a blow by the departure of one its partners, and European finance ministers were unable to agree on a new bank bail-in regime and broke off their talks in the early hours of yesterday, leaving an important element of the envisaged bank resolution regime unresolved." [my emphasis]
He quotes Morgan Stanleuy economist Joachim Fels:

The ECB says it will only activate the OMT [outright monetary transactions, the ECB plan that calmed the bond markets of the eurozone for the last year] if a government in trouble subjects itself to strict conditionality under an ESM program or credit line. However, any such arrangement would have to be approved by German parliament, and given the Bundesbank's stiff opposition to OMT and the Constitutional Court’s scrutiny of OMT, I don’t think German parliamentarians would approve an ESM program that they know will trigger OMT.

This is why I believe the OMT is practically dead and why the next big theme for the ECB will be broad-based QE [quantitative easing]. True, that’s unpopular in Germany too, but at least it doesn't require a vote in the Bundestag.
Wolfgang Münchau points to the recent rise in Italian interest rates and the immediate risks they pose for the eurozone as a sign that German Chancellor Angela Merkel has failed to use the last year to do anything serious to shore up the basics of the euro currency zone. (Da ist es wieder, unser Problem Spiegel Online 26.06.2013)

Chiara Vasarri reports in Italy Sells Maximum Amount at Auction After Banking Deal (1) Bloomberg Businessweek 06/27/2013:

Italy sold 2.5 billion euros ($3.3 billion) of bonds maturing in May 2023 at 4.55 percent, the highest since March 27 and up from 4.14 percent at a May 30 auction. Investors bid for 1.46 times the amount offered, up from 1.38 last month. The Treasury also sold 2.5 billion euros of debt maturing in 2018 at 3.47 percent, up from 3.01 percent. The total amount of the auction was at the top of the announced range. ...

Today’s sale comes as Italy’s public finances are under scrutiny after the Financial Times reported yesterday that the country faces losses of 8 billion euros on about 32 billion euros of derivatives. “There won’t be any negative impact on public accounts,” Finance Minister Fabrizio Saccomanni said at a press conference in Rome yesterday. “These are instruments used to manage interest-rate risk.”

Prime Minister Enrico Letta is facing the difficult task of boosting growth while keeping the budget commitments made with the EU at a time when bond markets are volatile and the legal issues of his ally and former premier Silvio Berlusconi threaten the stability of his government.

Yesterday his cabinet passed a package of measures to boost employment and delayed by three months a planned increase of the value-added tax from July.
Ambrose Evans-Pritchard reports in Italy could need EU rescue within six months, warns Mediobanca Telegraph 06/24/2013

Mediobanca, Italy’s second biggest bank, said its "index of solvency risk" for Italy was already flashing warning signs as the worldwide bond rout continued into a second week, pushing up borrowing costs.
“Time is running out fast,” said Mediobanca's top analyst, Antonio Guglielmi, in a confidential client note. "The Italian macro situation has not improved over the last quarter, rather the contrary. Some 160 large corporates in Italy are now in special crisis administration."

The report warned that Italy will "inevitably end up in an EU bail-out request" over the next six months, unless it can count on low borrowing costs and a broader recovery. ...

Italy’s €2.1 trillion (£1.8 trillion) debt is the world’s third largest after the US and Japan. Any serious stress in its debt markets threatens to reignite the eurozone crisis. This may already have begun after the US Federal Reserve signalled last week that it will begin to drain dollar liquidity from the global system.
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