Over the weekend Ignazio Visco, the Bank of Italy’s Governor warned of the downside risks to the central bank’s forecast for economic growth after the nation slipped into a recession in the last quarter of 2018. The recession, Italy’s third in a decade comes as the bank’s latest growth projection of 0.6% GDP growth for 2019 and 1% for 2020 start to look optimistic,
Again the euro took a hit touching 1.14 versus the dollar earlier today following: first yesterday’s unprecedented demands by the European Commission on the Italian government to revise their budget for 2019, followed by today’s weak PMI data across European majors – including 1 and 2 point shortfalls from forecasts for German manufacturing and services respectively.
Italy's 2019 budget approved by the cabinet on Monday includes a basic income for the poor, lowers the retirement age and offers a partial amnesty to settle tax disputes. (Here’s a question, is Italy the only country in the world to be lowering the retirement age?). Prime Minister Giuseppe Conte and his top ministers told reporters on Monday. Speaking after the cabinet signed off on the budget bill, Deputy Prime Minister Luigi Di Maio said the basic income to relieve poverty would kick off within the first quarter of the year.
Late last night, the United States, Mexico and Canada reached a new tri-lateral trade agreement that will replace the North American Free Trade Agreement (NAFTA) it was announced. Talks on the new deal have been ongoing for more than a year to replace the 24-year-old NAFTA agreement, which Trump famously called ‘the worst deal ever’. The new pact, which is being called the U.S.-Mexico-Canada Agreement (USMCA), will come up for review in six years, which, according to a senior American official, will give the US a ‘significant new form of leverage’ to make sure the agreement continues to be to the US’ liking.
This morning, the euro rose to a 10-day high along with sovereign yields across the EU as ECB Chief Economist, Peter Praet gave a rather typical presentation outlining the journey and challenges of “Monetary policy in a low interest rate environment” to the “Congress of Actuaries” in Berlin (I know, how did we forget to put this in the diary?). His formal remarks, as usual, were dry but a good synopsis of the factors and thinking that have guided the Central Bank’s current policy stance: highlighting the “innovative and bolder measures” particularly their “Asset Purchase Programme (APP) [which] has been the pivotal component of [their] strategy for countering and reversing the crisis.”
Holders of Italian 2-year debt brought new meaning to the idea of “paying the price for volatility” given that (until a fortnight ago) they actually prepaid – in negative yields – for the privilege of exposure to Italian market risks. In May alone, Italian short term yields went from -0.15% to close yesterday at 2.70%; 185bps of this 285bps move occurred yesterday. This was unprecedented and equates to 18 standard deviations beyond the average daily move over the past decade (which itself was quite high during the Eurozone Crisis of 2011/12).
Not that the German economy has fared poorly in the past four months, but the political stalemate that has endured over that period is finally moving forward - with Chancellor Angela Merkel’s conservatives (CDU/CSU) yesterday agreeing terms for a renewed ‘grand coalition’ with Martin Schulz and the SPD. But many on both sides still oppose the pairing which in some ways seems about as unmelodious as the UK’s Clegg-Cameron-Coalition of yesteryear. So in the typical drawn-out fashion a final vote on the deal, by half a million registered SPD members, is still required and expected by the 4th of March.
In a report today on the public finances of EU members, the European Commission (EC) has warned Italy to tighten fiscal policy by at least 0.2% of GDP or face sanctions. This target is what Rome had promised the EC earlier this month, but obviously the Commission have yet to see enough progress. An EU official commented, ‘Unless Italy specifies its commitments properly, next week will show that they are not compliant with the debt rule.’ Given that Italy ‘should’ be reducing its deficit by 0.5% of GDP and its debt by 3.6% of GDP per annum this warning already accommodates a fair amount of leniency.
Consider two countries: one with high public debt and Net Foreign Liabilities rated Baa2 versus one without Net Foreign Liabilities rated Ba1. History has shown that high levels of indebtedness greatly increase financial risks to creditors as investor sentiment becomes more volatile and repayment costs balloon. We believe the risks of this greatly increase when Net Foreign Liabilities exceed 50% of GDP and are typically unsustainable beyond 100% of GDP. Yet there are numerous examples across the world where countries with high levels of indebtedness are rated higher than net foreign creditors or countries with appropriate and sustainable levels of debt. Why is this?
Around 500 years ago during the Renaissance era a number of charitable money lenders were created across what is now Tuscany in Italy to combat the damaging effects of loan sharks. Back then merchant bankers still limited their business to the noble or political and religious elite until Franciscan Friars persuaded the Vatican to found a bank that would set interest rates at cost and take collateral. These banchi di pegn (or pawnbrokers) and similar banks then begun to spread with one rich trading city-state, that of Siena, creating their very own such bank with taxpayers’ money. This innovative project grew a core portfolio of agricultural loans along with other banking business to a previously neglected populous. After a significant loss financing the exploration of Christopher Columbus in 1492 its rotating structure of leadership instilled a risk-averse culture and lending practice.
1st March 2067 is the distant maturity of the latest €5bn bond issuance from Italy. Even in the wake of European immediate concerns, talk of the ECB reducing QE and Italian banks fears not to mention the Deutsche Bank furore - subscriptions for this first ever 50 year bond from ‘Il Bel Paese’ were 3.7x oversubscribed. €18.5bn of investor money was keen (or at least reluctantly persuaded) to bet on Italy’s ultra-long-term creditworthiness at underwhelming spread of 52 basis points over Bunds. Not us.
The Italian government has announced the date for the referendum on Constitutional Reform as December 4. This had been touted as a key event as Matteo Renzi publicly stated he would resign if it does not get passed: an all too credible risk given the rise of populist politics, a general backlash against austerity and the rise of the Five Star Movement in Italy. However, he has recently backed away from his statement about resigning emphasising that the referendum should be about the issue of reform and not a confidence vote on him per se; a wise move given the vote looks to be a close call with a large portion (35-40 percent depending on the poll) undecided (indeciso). There is no constitutional obligation for Renzi to immediately resign on the back of a ‘no’ vote.
Yesterday the Bank of England (BoE) found itself unable buy enough long dated gilts as investors continue to cling on to developed government bonds of all varieties. Following the BoE’s decision to cut the UK base rate and expand its quantitative easing programme by £60bn it only managed to receive offers to purchase £1.12bn of gilts with maturities over 15 years versus their target of £1.17bn. At least part of the reason for this shortage of availability is the more illiquid markets over the summ er – indeed the ECB overbought in earlier months in expectation of such illiquidity but the recent post Brexit expansion of QE obviously had no such option. This prevailing shortage, versus demand, of government bonds looks likely to remain a prolonged dilemma for central banks and investors alike.
Media coverage of Brexit has somewhat eclipsed the Italian local elections results; these look to be yet another example of populist politics gaining ground in a push back against incumbent regimes and the European austerity mantra. As we have said before, creating the euro currency union between creditors and debts without a European Treasury, unified fiscal policy and fully functioning redistribution mechanisms is problematic. Under the current system, the adjustment process to reduce imbalances has taken the route of austerity which has hit the debtor nations hardest in terms of weak growth and deflationary pressures, exacerbated by the lack of debt write-offs. Greece, Portugal and Spain have already experienced a good deal of political upheaval and this week there were signs that Italy could be heading this way too.
In what could be the most market disruptive intervention to date, today the European Central Bank (ECB) begins their Corporate Sector Purchase Programme (CSPP); meanwhile German 10-year bund yields touched new record lows of 0.034% (though have “nearly doubled” since) and around 15% of euro corporate investment grade debt is already in negative yield territory. The ECB first announced it would include corporate sector purchases to the Asset Purchase Programme (APP) on March 10 and details of the CSPP were released at the end of April, but markets have yet to find consensus as to how large and how effective this extreme measure will be in pushing inflation closer to the target of “below but close to 2%”.