In Between Days: Eurotrashed

by CC September 6, 2011 12:01 am • Commentary


The Yield on the benchmark 10-year bund fell to a record low Monday, while Italian yields rose on fears the government’s commitment to austerity and reform is weakening, and investors questioned the European Central Bank’s commitment to support Italian bonds indefinitely.

In the foreign-exchange market, the euro tumbled fast against the dollar and the safe-haven Swiss franc. The euro fell under $1.41 against the dollar to mark a decline of nearly 1% from its highest point of the day.

The September bund futures contract hit a record high of 138.36 while the 10-year German bund yield fell to a record low of 1.85%, down 0.15 percentage point from Friday.

Italian 10-year bond yields rose 0.28 percentage point to 5.54%, taking the spread to bunds to 3.70 percentage points, according to Tradeweb. Spanish, Belgian, Irish, Portuguese and Greek yield spreads over Germany were also wider.

Fears that the debt crisis will spread to Italy, considered too large for a Greek-style bailout, continue to worry investors, even though the ECB bought Italian and Spanish bonds again Monday, and revealed that it settled €13.31billion in government bond purchases last week.

One worry is that the ECB might reduce or stop its purchases. Incoming ECB head Mario Draghi said Monday the ECB’s sovereign bond-buying program is temporary, and market watchers point out that Italy needs to deliver on its austerity and reform program to keep the ECB happy.

“The ECB [bond market] intervention is the counterpart of fiscal consolidation, the rescue is conditional,” said Laurent Bilke, Nomura International’s head of European rates strategy, in a research note.

Italy has been criticised for failing to introduce a final version of its €45 billion austerity package, although Paolo Romani, Italy’s industry minister, said late Sunday that the government was sticking to its plan to push the measures through parliament by Sept. 15.

“Italy is a debacle,” said one trader.

There is increasing speculation that Italy will be downgraded. Société Générale strategists said in a research note that a downgrade looks probable due to the budgetary and macroeconomic outlooks, uncertainties about the Italy’s ability to access market funding, and its high rating relative to peers, especially at Moody’s Investors Service, which has had its Aa2 rating on review for possible downgrade since June 17.

Greek two-year bond yields rose by over three percentage points and are closing in on 50%, according to Tradeweb.

Talks between Greece and visiting international inspectors were suspended last week amid a dispute over new government cutbacks and their impact on the country’s economy.

The Economist

Some of this could be a hangover from Friday’s jobs report in the US, and from the lawsuit launched by an arm of the government against the banking sector. But Europe’s wounds are also self-inflicted. Let us sum up the recent news. The Greek talks with its multinational lenders have been suspended (broken down?) on signs the government is missing its targets; Italy’s politicians are backtracking from the measures unveiled in its austerity budget. Europe’s Plan A – that countries will bring their debts down through fiscal discipline while the markets wait patiently – looks less and less likely to succeed. In the FT, Wolfgang Munchau said that

the very least one should expect is for the eurozone to abandon all austerity measures with immediate effect

Actually, that is rather a lot to expect. Just to illustrate the confusion among policymakers, Christine Lagarde, the new head of the IMF, said at the weekend that European countries should

consider stimulus measures to drive growth

while Jean-Claude Trichet, head of the ECB, called for faster implementation of austerity measures.

Plan B for the euro-zone was for fiscal union, meaning that the Germans would guarantee the debts of the periphery. But with Angela Merkel suffering her fifth regional election defeat of the year, the German government will be more reluctant than ever to sign a blank cheque.

While the authorities bicker, the borrowing costs of banks are rising as US money market funds retreat from the region. The costs of insuring against European corporate defaults has risen 7% today. That will make the banks even less keen to lend; the annual growth rate of private sector lending was just 2.4% on the latest data.

Animal spirits may not be the only factor that drives an economy. But when you consider all the above factors – sovereign debt crisis, fiscal austerity, bank funding pressures, weak credit growth, falling markets, political drift – the background facing consumers and businesses is very gloomy. Only those German companies exporting to China can feel immune.


Jean-Claude Trichet and Mario Draghi, the current and incoming chiefs of the European Central Bank, pointedly urged European leaders to move quickly to ensure that the euro zone’s debt crisis does not become seriously worse.

Europe needs to “make a quantum step up in economic and political integration,” Mr. Draghi said as the bond yields of Greece, Italy and other countries with weak finances jumped Monday amid investor fears that such efforts might be failing. He and Mr. Trichet addressed a forum in Paris that focused on the world three years after the collapse of Lehman Brothers.