Italy faces another bond market crisis

The situation in Italy has returned to what we now consider as a bond market danger zone although this time around the mainstream media seems much less interested in a subject which it was all over only a fortnight ago. Before we get to that as ever we will prioritise the real economy and perhaps in a type of cry for help the Italian statistics office has GDP ( Gross Domestic Product) per capita at the top of its page. This shows that the post Second World War surge was replaced by such a decline since the 28,699 Euros of 2007 that the 26,338 of last year took Italy back to 1999. The lack of any growth this century is at the root cause of the current political maelstrom as it is the opposite of what the founders of the Euro promised.

Retail Sales

These attracted my attention on release yesterday and you will quickly see why.

In April 2018, both the value and volume of retail trade show a fall respectively of -4.6% and -5.4%
comparing to April 2017, following strong growth in March 2018.

Imagine if that had been the UK Twitter would have imploded! As we look further we see that there seems to be an Italian spin on the definition of a recession.

In April 2018, the indices of retail trade saw a monthly recession, with value falling by 0.7% and volume
dropping by 0.9%.

Taking a deeper perspective calms the situation somewhat but leaves us noting a quarterly decline.

Notwithstanding the monthly volatility, looking at the underlying pattern, the 3 months to April picture
reports a slight decline as value decreased by 0.5% and volume contracted by 0.2%.

This is significant as this is supposed to be a better period for the Italian economy which has been reporting economic growth for a couple of years now. It does not have the UK problem of inflation impacting on real wages because inflation is quite subdued.

In May 2018, according to preliminary estimates, the Italian harmonised index of consumer prices (HICP) increased by 0.4% compared with April and by 1.1% with respect to May 2017 (it was +0.6% in the previous month).

Actually the rise in inflation there may further impact on retail sales via real wages. Indeed the general picture here sees retail sales in April at 98.6 compared to 2015 being 100. Seeing as that is supposed to have been a better period for the Italian economy I think it speaks for itself.

The economy overall

This is consistent with the general European theme we have been both observing and expecting. From yesterday’s official monthly report.

The downturn in the leading indicator continues, suggesting a deceleration in economic activity for the coming months.

This would continue the decline as in terms of GDP growth we have seen 0.5% twice then 0.4% twice and then 0.3% twice. Ironically that had shifted Italy up the pecking order after the 0.1% for the UK and the 0,2% for France after its downwards revision. But the detail is not optimistic.

Italian growth has been fostered by change in inventories (+0.7 percentage points) and by domestic consumption expenditures (+0.3 percentage points).

The inventory position seems to be a case of “what goes up must come down” from the aptly named Blood Sweat & Tears and we have already seen that retail sales will not be helping consumption.

The trade position is in general a strong one for Italy but the first quarter showed a weakening which seems to have continued in April.

In April, exports toward non-EU countries recorded a contraction (-0.9% compared to the previous month) less marked than in the previous months (- 3.1% over the last three months February-April). In the same quarter, total
imports excluding energy showed a negative change (-0.7%).

So lower exports are not good and lower imports may be a further sign of weakening domestic demand as well. As ever the monthly data is unreliable but as you can see below Italy’s vert strong trade position with non EU countries has weakened so far this year as we mull the stronger Euro.

The trade balance registered a surplus of 7,141 million euro compared to the surplus of 7,547 million euro in the same period of 2017.

An ominous hint of trouble ahead comes if we note the likely impact of a higher oil price on Italy’s energy trade balance deficit of 12.4 billion Euros for the first four months of 2018.

Bond Markets

These are being impacted by two main factors. Via @liukzilla we are able to award today’s prize for stating the obvious to an official at the Bank of Italy.


It seems to have been a day where the Bank of Italy is indeed in crisis mode as we have also had a case of never believe anything until it is officially denied.


The other factor is the likelihood that the new Italian government will loosen the fiscal purse strings and spend more. It is already asking the European Union for more funds which of course will come from a budget that will ( May?) lose the net contribution from the UK.

Thus the bond market has been sold off quite substantially again this week. If we look at it in terms of the bond future ( BTP) we see that the 139 and a bit of early May has been replaced by just under 123 as I type this. Whilst there are implications for those holding such instruments such as pension funds the main consequence is that Italy seems to be now facing a future where the ten-year benchmark yields and costs a bit over 3%. This is a slow acting factor especially after a period where the ECB bond purchases under QE have made this cheap for Italy. But there has already been one issue at 3% as the new drumbeat strikes a rhythm.

There has also been considerable action in the two-year maturity. Now this is something that is ordinarily of concern to specialists like me but the sharp movements mean that something is going on and it is not good. It is only a few short week’s ago that this was negative before it then surged over 2% in a dizzying rise before dropping back to sighs of relief from the establishment. But today it is back at 1.68% as I type this. In my opinion something like a big trading position and/or a derivative has blown up here which no doubt will be presented as a surprise at some future date.

Meanwhile here is the Governor of the Bank of Italy describing the scene at the end of last month.

Having widened considerably during the sovereign debt crisis, the spread between the average cost of the debt and GDP growth narrowed to around
1 per cent. It could narrow further over the next few years so long as the economic situation remains positive. If the tensions of the last few days subside, the cost of debt will also fall, if only slightly, when the securities
that were placed at higher rates than newly issued ones come to maturity.


So to add to the other issues it looks like the Italian economy is now slowing and of course it was not growing very much in the first place. This makes me think of the banks who are of course central to this so let us return to Governor Visco’s speech.

Italian banks strengthened capital in 2017. Common equity increased by €23 billion, of which €4 billion was provided by the Government for the recapitalization of Monte dei Paschi di Siena.

Those who paid up will now be mulling losses yet again as even more good money seems to be turning bad and speaking of bad.

NPLs, net of loan loss provisions, have
diminished by about a third with respect to the end of 2015, to €135 billion. The coverage ratio, i.e. the ratio of the stock of loan loss provisions to gross NPLs, has reached 53 per cent, a much higher level than the average for the
leading European banks.

On and on this particular saga goes which will only really ever be fixed by some economic growth which of course is where we came in. Also whoever has done this has no doubt been suffering from a sleepless night or two recently.

The decrease in the stock of NPLs is partly due to the sharp rise in sales on the secondary market, facilitated by the favourable economic situation
(€35 billion in 2017 against a yearly average of €5 billion in the previous four years). This year sales are expected to reach €65 billion for the banking
system as a whole.





11 thoughts on “Italy faces another bond market crisis

  1. Excellent blog. As you say, the mainstream media has almost stopped talking about Italy. Since the election, several months ago, the attitude to Italy seems to have been going along the following path:
    1. Let us wait and see whether anyone can form a working majority
    2. It will probably be the old parties somehow;
    3. Oh my God, It’s those crazy Lega and M5S people. They’ll crater the economy, the Euro, the world. Doom and catastrophe;
    4. Hang on a moment, the president has stopped it. We are all saved;
    5. Oh help, we are going to have another election;
    6. Oh great, a new coalition has been formed between those nice stable and sensible parties, the Lega and M5S;
    7. Let’s go back to talking about Trump, as Italy is old news.

    It seems to me that the bond markets are going to pay a lot more attention the actions of the Italian government than the mainstream media, which has already forgotten that the manifesto would somewhat add to Italy’s debt if it carries out its promises.

    • Hi James and thank you

      If a ten-year bond yield above 3% was an issue a fortnight ago then over 3.1% tonight is in my book but apparently not the MSMs. To my mind the trading pattern has been weak with for example the rally in bond prices yesterday morning, later reversing, then closing as much down as it had been up.

      With the size of Italy’s national debt these things matter. It has to its advantage that it has a decent average maturity but as an example there are more debt auctions next week so it takes its time but the clock is now ticking.

  2. ‘In my opinion something like a big trading position and/or a derivative has blown up here which no doubt will be presented as a surprise at some future date.’

    Shaun,any chance you could expand on this?

    I really don’t know who’s buying Italian bonds when you can get near 3% on the US 10 yr.

    • Hi Dutch

      I am thinking along two lines which might be cause or some combination of.

      1. A derivative position for example written to take premium based on the fact that the ECB has your back and the 2 year yield therefore will not be allowed to rise. Of course that turned out to be an assumption not a fact. But as the market moves against you the required size of hedge rises and rises so it is unstable. No fun at all…..But it could explain the spike in yield over 2% if the trader was instructed to hedge the lot.

      2. A similar scenario but simply because it is assumed that the ECB has the market docile position sizes get much larger after all trading here is “free money”. So rather than trading with X Euros you trade with 10X. Again on any move they may have had to get out and large volumes one way were picked off by others.

    • Hi AnneD and thanks for the link

      I would imagine similar thoughts are being expressed in Madrid, Paris and Brussels about this as investment trends like that are often widespread. It would have worked well in the phase when ECB QE drove Italian bond yields lower so those who have been there for a while may not be too badly off.
      I have made the case in various places that low yielding bonds ( with high prices ) are inherently risky but of course the establishment knows better and then cries “surprise” when it is goes wrong.

  3. Hi Shaun, thanks for watching this one. The FT story today is that some funds made a killing, shorting the Italian bonds in anticipation of their risk premia, back in early May. I am intrigued whether this oil price increase has the ability to cause a enrgey supply shock, I am not enjoying 133p per litre, I’ve started driving for economy again…

    regards Paul

    • Hi Paul

      Well played to those who were ahead of the game. As to the energy price it must be hurting Italy as it is a big energy importer. Maybe we are seeing a sign of this in the way that the new PM Conte wants much better links with Russia and Putin.

  4. Some interesting double standards: if Italy runs a trade surplus, that is okay and nothing to do with the euro; if Germany runs a surplus that is down to the evil Krauts manipulating the euro. Then, Italy reached its highest GDP in 2007 after seven years in the euro, but it is the euro’s fault that GDP has fallen back, once all the debt was exposed. The answer now is to revert to the lira ….

    • Hi David

      Much of that is fair and it remains a conundrum that Italy can export but somehow never seems to have the same enthusiasm for other economic activity. The lower interest-rates gave a cheap hit but it ran out and this time round going even lower has not helped overall at all.

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