The European debt has experienced a hectic year and with an unexpected end: Italy has become the black sheep of investors ahead of countries like Greece. From Rome they have seen how their ten-year sovereign bond has experienced the greatest increase in profitability of the entire old continent, going from 1.05% to 4.4%. This means that investors have ignored transalpine fixed income in favor of other investments or countries that offer more certainty.
In fact, the Italian risk premium (the difference with respect to the German bond) is at 217 points, being the worst among the most important countries in the Eurozone. Greece is in 212 being the only one that follows the track. On the other hand, Spain and Portugal are next with a much more rosy situation (109 and 103 points respectively). France places its risk premium at 53 points.
Italy is in a real public debt crisis. This is the most delicate situation in this section since the 2008 crisis and proof of this is the yield on its bonds, which have reached 2013 highs. In 2021, the country had a debt of 2,679 billion euros, represented more of 150% of its GDP and placing the country among the most indebted on the planet along with others such as Japan, Sudan or Greece.
According to the latest data from the Bank of Italy, the debt would already be at 2.77 trillion. However, the blow in 2022 may be much greater for the transalpine nation, as there has been a perfect storm that is causing doubts to take over investors’ minds and abandon the idea of taking Italian bonds.
Joaquín Robles Fernández believes that this over-indebtedness is key and will cause more pain for fixed income in the coming months. “The bond market will continue to be very choppy due to more rate hikes. Investors will be watching to see what happens and there will be less liquidity. The market will be very difficult.”
Why Italy?
In the first place, the market is primed with Italian letters due to political chaos, since Italy, which came from a technocratic government led by the former president of the Central Bank Mario Draghi, has blown up this year and, in its place, has won Georgia Meloni. The ex-banker’s change for eurosceptic and far-right politics has filled the market with uncertainty, although there is still caution about how the country’s economic direction will be under his command.
From FX Street they highlight this political chaos as the main differential element of economies such as Spain, which also has problems with its debt. “It is the third largest economy in Europe and there is a highly divided government with the possibility of a break at any time and new elections.” They also point out that his speech suggests that, when in doubt, “they will go for social reforms” instead of betting on a normalization of their debt or austerity policies. In short, the market sees that they are going to go for more and paying more money next year and they already have a structural deficit above 6%”, so the short-term future does not look very rosy.
On the other hand, the high dependence of the Mediterranean nation on Russian gas is being a headache that prevents solving its high debt. Before the crisis, it was the second largest buyer of Russian gas on the continent behind Germany, so the rise in energy prices has particularly affected its economy, one of the main victims of the European sanctions against the Government of Putin after the invasion of Ukraine.
In fact, Italy has already announced that it will raise its debt by 4.5% in 2023 to achieve 30.5 billion euros of liquidity in order to stop the escalation in energy prices. The idea of the measure announced by Rome was to dedicate 9,500 million of that money in direct aid since last November and close to 21,000 million euros to help families and companies throughout the coming year.
Last but not least, the European Central Bank is going to continue raising interest rates and stopping its ‘stimulus’. Lagarde has stopped buying debt from euro zone countries at the level of previous years and will continue to gradually reduce her balance sheet. According to Bank of America calculations, the ECB, which used to buy about 120% of the net issuance of Italian bonds, will now buy only 30%.
Robles Fernández, defends that “it has been one of the most chaotic years of the last decade for fixed income in peripheral countries.” According to the expert, until now “the market was adulterated by the ECB” and for this reason the current situation is leading to great volatility and great uncertainty for the most indebted countries. In this sense, the current chaos would have caused “investors to abandon the bonds with the highest risk to focus completely on the German bund”, which offers better guarantees. And this situation can bring more problems for Italy because “a high national bond can cause the debt of its mother-in-law companies to have a contagion effect with respect to the national one.
Regarding interest rate increases, the European Central Bank has already launched four consecutive increases, going from interest rates of 0% in June to reaching 2.5% in December, levels not seen since 2008. Higher interest rates make debt more expensive and Italy has already openly charged Christine Lagarde. Ministers of the current government such as Guido Crosetto (Defense) have stated that these are “crazy” and “nonsense” decisions. The deputy prime ministers Antonio Tajani and Mateo Salvini have also joined the complaints.
Despite everything, and despite the fact that the Italian debt is entering a negative spiral, the market does not see a possible default by the third largest economy in the Eurozone. According to the Mediterranean nation’s Credit Default Swap, there is only a 2.24% probability of default on loans on a 40% recovery rate.
Rebound of its economy
Despite all these ills that are weighing down its debt and its deficit, its economy is growing strongly, being one of the surprises of the year. According to the latest data, its GDP is already 1.8% higher than the pre-pandemic, while countries like Spain are still 2% below and other large European countries such as France or Germany have barely exceeded it by tenths.
UBS specialists remarked in their latest report that a construction sector ‘on fire’ for booming housing is pushing the Italian economy above that of its peers. However, this ‘renaissance’ does not prevent the country from facing serious problems for its debtors and to avoid falling into deficit this year.
And the Spanish bond?
Apart from the Italian situation, the rest of the peripheral countries have also seen their situation in terms of fixed income worsen decisively. The case of Spain stands out, with a debt that exceeded 1.5 trillion euros, which translates into 116% of GDP, according to the latest data from the Bank of Spain.
The policies of the European central bank and the worse economic situation have caused the yield of the ten-year bonds to reach the maximum of February 2014, with 3.337%. A situation that will presumably worsen as interest rates and the movements of the European Central Bank accelerate in 2023.
From FX Street they warn that, although the Spanish debt “is not the worst of the large economies in Europe” it is in a “bad situation”. It must be taken into account that the country “is not growing compared to 2019 and has many economic problems with a labor market that is not as dynamic as those of its surroundings.” A more damaged economy with higher unemployment than the rest of the European countries and an equally high debt would be affecting the appetite of investors, apart from the ‘flight’ of the European Central Bank from peripheral debt.
What will happen in 2023?
Looking ahead to 2023, the experts agree that more ‘pain’ is coming for European fixed income and in particular for Greece, Spain, Portugal and Italy. The ECB has already announced “significant increases” in 2023. Experts believe that the cycle of increases will continue for longer than that of the United States, since it started later and this will affect the debt market.
Although Blackrock, Amundi and Vanguard believe that now is a good time given the yield on bonds and the prospects that the situation will improve in the medium-long term, they also warn that 2023 will be difficult. In the latest Citi report, they warn that, given Lagarde’s message at the last meeting, “we suggest that the yield of the German Bund will be at 2.7% in the next year” and the rest of the bonds will follow suit with more uploads.
From FX Street they believe that part of the problem will be that a United States that exits before the rate hike cycle will present itself as a much more interesting option for investors than buying Spanish or French bonds. “Fixed income may be a star product because there is a very low default rate and profitability is rising. However, the opportunity is greater in the US and in corporate debt.”
This is how Italy has become the ‘black sheep’ of European debt behind Spain and Greece