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.





Are interest-rates on the rise now?

As we find ourselves heading into the second decade of the credit crunch era we find ourselves observing an interest-rate environment that few expected when it began. At the time the interest-rate cuts ( for example circa 4% in the UK) were considered extraordinary but the Ivory Towers would have been confident. After all they had been busy telling us that the lower bound for interest-rates was 0% and many were nearly there. Sadly for the Ivory Towers the walls then came tumbling down as Denmark, the Euro area , Sweden, Switzerland and Japan all entered the world of negative official interest-rates.

Even that was not enough for some and central banks also entered into sovereign and then other bond purchases to basically reduce the other interest-rates or yields they could find. Such QE ( Quantitative Easing) purchases reduced sovereign bond yields and debt costs which made politicians very happy especially when they like some official interest-rates went negative. When that did not work either we saw what became called credit easing where direct efforts went into reducing specific interest-rates, In the UK this was called the Funding for Lending Scheme which was supposed to reduce the cost of business lending but somehow found that  instead in the manner of the Infinite Improbability Drive in the Hitchhikers Guide to the Galaxy  it reduced mortgage interest-rates initially by around 1% when I checked them and later the Bank of England claimed that some fell by 2%.

What next?

Yesterday brought a reminder that not everywhere is like this so let me hand you over to the Reserve Bank of India.

On the basis of an assessment of the current and evolving macroeconomic situation at its
meeting today, the Monetary Policy Committee (MPC) decided to:
• increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis
points to 6.25 per cent.
Consequently, the reverse repo rate under the LAF stands adjusted to 6.0 per cent, and the
marginal standing facility (MSF) rate and the Bank Rate to 6.50 per cent.

There are two clear differences with life in Europe and the first is a rise in interest-rates with the second being that interest-rates are at or above 6% in India. It feels like another universe rather than being on the sub-continent but it does cover some 1.3 billion people. Sometimes we over emphasise the importance of Europe. As to why it raised interest-rates the RBI feels that the economy is going well and that inflation expectations are rising as domestic inflation ( official rents) has risen as well as the oil price.

The US

This has moved away from zero interest-rates and now we face this.

to maintain the federal funds rate in a target range of
1½ to 1¾ percent

It seems set to raise interest-rates again next week by another 0.25% which has provoked Reuters to tell us this.

With inflation still tame, policymakers are aiming for a “neutral” rate that neither slows nor speeds economic growth. But estimates of neutral are imprecise, and as interest rates top inflation and enter positive “real” territory, analysts feel the Fed is at higher risk of going too far and actually crimping the recovery.

Personally I think that they do not understand real interest-rates which are forwards looking. So rather than last months print you should look forwards and if you do then there are factors which look likely to drive it higher. The most obvious is the price of crude oil which if we look at the West Texas Intermediate benchmark is at US $65 per barrel around 35% higher than a year ago. But last month housing or what the US callers shelter inflation was strong too so there seems to be upwards pressure that might make you use more like 2.5% as your inflation forecast for real interest-rates. So on that basis there is scope for several more 0.25% rises before real interest-rates become positive.

One point to make clear is that the US has two different measures of inflation you might use. I have used the one that has the widest publicity or CPI Urban ( yep if you live in the country you get ignored…) but the US Federal Reserve uses one based on Personal Consumption Expenditures or PCE. The latter does not have a fixed relationship with the former but it usually around 0.4% lower. Please do not shoot the piano player as Elton John reminded us.

If we move to bond yields the picture is a little different. The ten-year seems to have settled around 3% or so ( 2.99% as I type this) giving us an estimated cap for official interest-rates. Of course the picture is made more complex by the advent of Quantitative Tightening albeit it is so far on a relatively minor scale.

The Euro area

Here we are finding that the official line has changed as we await next week’s ECB meeting. From Reuters.

Money market investors are now pricing in a roughly 90 percent chance that the European Central Bank will raise interest rates in July 2019, following hawkish comments from the bank’s chief economist on Wednesday.

In terms of language markets are responding to this from Peter Praet yesterday.

Signals showing the convergence of inflation towards our aim have been improving, and both the underlying strength in the euro area economy and the fact that such strength is increasingly affecting wage formation supports our confidence that inflation will reach a level of below, but close to, 2% over the medium term.

For newer readers he is saying that in ECB terms nirvana is near and so it will then reduce policy accommodation which is taken to mean ending monthly QE and then after a delay raising interest-rates.

So it could be a present from Mario Draghi to his successor or of course if he fails to find the switch a job he could pass on without ever raising interest-rates in his eight years as President.


Before I give my opinion let me give you a deeper perspective on what has been in some cases all in others some of our lives.

Since 1980, long-term interest rates have declined by about 860 basis points in the United States, 790 basis points in Germany and more than 1,200 basis points in France. ( Peter Praet yesterday)

On this scale even the interest-rate rises likely in the United States seem rather small potatoes. But to answer the question in my title I am expecting them to reach 2% and probably pass it. Once we move to Europe the picture gets more complex as I note this from the speech of Peter Praet.

the underlying strength in the euro area economy

This is not what it was as we observe the 0.4% quarterly growth rate in Euro area GDP confirmed this morning or the monthly and annual fall in manufacturing orders for Germany in April. Looking ahead we know that narrow money growth has also been weakening. Thus the forecasts for an interest-rate rise next June seem to be a bit like the ones for the UK this May to me.

Looking at the UK I expect that whilst Mark Carney is Bank of England Governor we will be always expecting rises which turn out to be a mirage. Unless of course something happens to force his hand.

On a longer perspective I do think the winds of change are blowing in favour of higher interest-rates but it will take time as central bankers have really over committed the other way and are terrified of raising and then seeing an economic slow down. That would run the risk of looking like an Emperor or Empress with no clothes.





Can Mario Draghi and the ECB help Italy?

Yesterday was quite an extraordinary day especially in Italian markets. However I wish to move on to consider things from the new tower of the European Central Bank. So as we move geographically to the Grossmarkthalle in Frankfurt we would have seen concern and probably not a little panic. The phone lines would have been burning between Frankfurt and the Bank of Italy as they discussed how to respond. At first this would have been on a tactical level about the ongoing QE ( Quantitative Easing) bond buying programme but of course the higher echelons and strategy would pretty quickly have been in play. However you spin it the billion Euros or so a week of buying of Italian bonds might have lasted all of thirty minutes if that if it was spent all in one go! I do not know if the weather was the same as in London but the storms were appropriate.

There was no formal Governing Council Meeting but I am sure that President Draghi and the Executive Board would have been in contact and others would have taken an interest. Some may have had a wry smile as up to this week the main issue would have been the location of the meeting next month in Riga Latvia. There the issues would be corruption, money-laundering and in some respects the ECB trying to put itself outside the legal system. Now the question on everyone’s minds would be Italy and the political crisis triggered there and in particular the impact on debt markets

What could the ECB do?

The obvious first move concerns the QE bond buying. This is something of a new situation as it is the first case of a major bond market facing a price rout with both flow QE as in ongoing purchases and a stock of it as the ECB has bought around 342 billion Euros of Italian government bonds so far. Thus the latter would not be sold and it would have been bought mostly from those who might have done in the situation unfolding. Yet it was not enough and the ECB has tied its own hands.

What I mean by this is that in order to get its 19 constituent nations to agree to the QE plan it buys according to their Capital Key. This is the effective shareholding of each country and reflects factors such as their relative GDP and Italy is approximately 17.5% so that is what it gets. There is scope to vary this but not a lot as Mario Draghi explained in January.

 The ECB doesn’t favour certain countries over others in its PSPP purchase programme implementation. As you know, purchases are guided by the ECB’s capital key, which takes into account GDP and population. Now, focusing excessively on any particular purchase period, for example on 2017 only, could result and yield wrong interpretations. The overall stock of Eurosystem PSPP holdings is the relevant metric for any assessment of the programme and not the recent purchase flows.

Back then too much German debt was held and too little Portuguese.

These flows can differ as the design of the programme is flexible and the distribution of actual purchases often deviates from the ECB capital key.

So whilst there is flexibility there is nowhere near enough especially as the numbers would be released next Monday and everyone would see. Actually I think the flexibility was used up last Wednesday when the ECB in baseball terms stepped up to the plate and then withdrew. No doubt there were discussions about modifying the programme but I doubt they got far and the word nein would not have been needed.

Some have been suggesting the ECB could buy more but at the moment that is a non-starter. Of course we have seen such things change but persuading German and other taxpayers to potentially bankroll a new coalition government in Italy hoping to “spend spend spend” will not be easy.

Securities Markets Programme

This was used in the Euro area crisis.

About e220 billion (bn) of bonds (par
value, excluding redemptions) were acquired from 2010 to early 2012. Greece, Ireland, Portugal, Spain, and

As described it does seem to fit the bill.

First, purchases within the SMP occurred during a severe sovereign debt crisis, when sovereign yields in several euro area countries were high, rising, and volatile.

Of course you could argue that in spite of yesterday’s surge in Italian bond yields with the ten-year around 3% as I type this that is not high compared to the 7% of the Euro area crisis. Also the programme is shown as terminated on the ECB website although 84 billion Euros of bonds are still held.

However it is worth noting because the replacement called OMTs or Outright Monetary Transactions have never been used.

Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above.

That is an issue because Italy is not in one and you could hardly see Mr. Sissors persuading the Italian parliament of much at all right now let alone this. That is unfortunate from the point of view of the ECB because like the SMP it operates like this.

Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.

This matters because there have been some extraordinary events in short dated Italain government bonds. As recently as the fifteenth of this month the two-year yield was negative reflecting the easy ECB monetary policy and the -0.4% Deposit Rate. Yesterday it rose as high as 2.8% and today it is 2%. So some extraordinary moves with t hose who bought a fortnight ago feeling rather silly I guess.

Wider Moves

The issue here for the ECB is that not only has it been tapering its QE programme but it has been hinting at its end. That makes it awkward to fire it back up. Of course should the current weaker patch for the economy persist then it might provide an excuse/reason but it is just as true that the effect on inflation from the higher oil price is pushing in the opposite direction.


The ECB finds itself between a rock and a hard place in two respects. The first is that additional bond purchases might turn out to be an own goal if the likely governing coalition returns to its proposal involving the ECB writing off 250 billion Euros of it.Next comes the issue of Greece which does not qualify for QE in spite of enormous efforts and it might reasonably ask how a fiscally expansionary government in Italy qualifies?

There could be specific efforts to help the Italian banks although of course they have received an extraordinary amount of help as it is! Most still seem to be troubled and burdened with bad and sour loans. Mario Draghi was always very keen on buying Asset Backed Securities which I always thought was a way of helping the Italian banks in particular but as we look we see a barrier.

At the time of inclusion in the securitisation, a loan should not be in dispute, default, or unlikely to pay. The borrower associated with the loan should not be deemed credit-impaired (as defined in IAS 36).

Here is my suggestion for the ECB loudspeakers from The Sweet.

Does anyone know the way, did we hear someone say
(We just haven’t got a clue what to do)
Does anyone know the way, there’s got to be a way
To blockbuster


Meanwhile the Euro has recovered a bit today and is above 1.16 versus the US Dollar.



The Italian bond and bank crisis of May 2018

Oh what a difference a couple of days can make, especially in Italy right now. However we can see the cause of this quite easily and have done so more than a few times in the past. Back at the end of the last century when the Euro currency concept was being prepared its supporters argued that it would bring economic convergence to its member countries. The reality for Italy has been this if we look for an individual measure of economic performance.

The convergence issue has been a disaster for Italy. Ironically it seemed to be holding station with Germany before the Euro began but since it the German locomotive has powered ahead leaving the Italian carriage in a siding. If you had set out to diverge the two economies it would have been hard to do better ( worse?) than this. Also my theme that Italy struggles in the relatively good times was at play in the early part of the century. Then it was hit hard by the credit crunch and the Euro area crisis and sadly has still not fully sorted its banking problems.


Another way of observing the Italian economic experience has been provided in a paper from the Universities of Modena and Rome which point out another reversal.

The paper explores the changing risk of poverty for older and younger generations of Italians throughout the republican period, 1948 to the present day. We show that
poverty rates have decreased steadily for all age groups, but that youth has been left behind. The risk of poverty for children aged 0-17, relative to adults over 65, has
increased steadily over time: in 1977, children faced a risk of poverty 30 percent lower than the elderly, but by 2016 they are 5 times likelier to be poor than someone in the age
range of their grandparents.

It is easy to always look at the bad side so let us take a moment of cheer as we note that in general poverty has fallen since the second world war and mankind has stepped forwards. However the rub as Shakespeare would put it is that the times may be a-changing and the poverty we see now in Italy is concentrated in younger age groups. This reminds me of another statistic.

Youth unemployment rate (aged 15-24) was 31.7%, -0.9 percentage points over the previous month.

So as the overall unemployment rate is 11% then the youth unemployment rate must be treble that of older age groups. Which means that they have gone back to the future.

As a matter of fact, young Italians today face approximately the same risk of poverty as their equals in age in the 1970s. No economic miracle has happened for them, and none is expected.

This seems to have been a deliberate policy as we note this.

 Our analysis points to the welfare state, which offers better protection for the elderly than it does for
the young and their families………More importantly, the
elderly continued their march towards a poverty-free existence, while the youth did not.

This leads to a rather chilling statement.

Overall, in the last seven decades, Italy has become no country for young people.

Some of this is an international issue as for example the UK had the triple-lock for the basic state pension but some is specifically Italy.

National Debt

This is an issue but not in the ordinary way. This is because what can be described as the third biggest national debt in the world has not be caused by fiscal recklessness. In recent times Italy has been restrained. The problem has been the one described above which is the lack of economic growth. On such a road to nowhere even small fiscal deficits see the national debt rise in relation to economic output or GDP (Gross Domestic Product).

Perhaps the new Prime Minister will live up to his “Mr. Scissors” nickname in this area but it will be hard for a man facing a confidence vote to do much I would think.

Italian bonds

As you can imagine this has felt just like old times for me and in spite of yesterday being a glorious bank holiday at least until the evening thunderstorm I was transfixed for a while by what was happening. Two old rules of mine worked as well.

I like the idea of applying something I was taught at the LSE albeit with a personal spin as so much has found its way into the recycling bin. Nobody seems to pick it up either which means it is set fair for the future. The other is that you buy an intraday fall of more than two points. That worked as well but with the caveat that it was a case of the “quick and the dead” and you would have been stopped out today.

Moving to the state of play as I type this we see what has become a bloodbath. The Italian BTP bond future has fallen 5 points to a low of 124 and this compares to a bit over 139 as recently as the 7th of this month. Putting it another way the ten-year yield has risen from 1.76% to 3.1%. This may not seem large moves so let me explain the issue in the QE ( Quantitative Easing) era.

  1. They are bigger than you think and an example of this is the way the US Treasury Bond market used to have a trading halt after two point moves. Annoying at the time but does give a breather.
  2. In the QE era there is the view that the central bank will bail things out and that to quote Flo “the dogs days are over”
  3. This may have tempted investors to increase position size to make a profit which of course would now be in trouble.
  4. As implied volatilities fall it is tempting not only to put on derivative positions but to increase their size as human nature is particularly vulnerable at such times.

We have two clear examples of such events. One I traded through which was the LTCM crisis of the late 90s which was a case of intellectual arrogance and of course we had the travails of the VIX index earlier this year.

Whatever It Takes

The famous saying from ECB President Draghi from the summer of 2012 of course had to save the Euro as an implication but some translated it as “to save the Italian banks”. We have followed over time the multitude of issues here but as we looked at last week another problem emerged on Thursday. From @YanniKouts.

The minute the markets will realize that Italy will restructure its debt, the Italian banks and eventually the economy will collapse. Corralito.

Since then the share prices of the Italian banks have moved into yet another bear market. Our old friend Monte Paschi the world’s oldest bank is at 2.32 Euros down 5% today or 1 Euro lower than a fortnight ago. Those of a nervous disposition might like to look away now as I point out that compares to a pre credit crunch peak of more like 7700 Euros. In a way the Italian financial crisis can be summed up by Prime Minister Renzi saying it was a good investment. Oh and as Polemic Paine reminds us a past theme is in play right now.

Waiting for second round effects from all the private hands that clamoured to buy the Italian banks’ dodgy debt.

These days the role of the ECB has increased as of course it is also the banking supervisor which I think is a bit like being Liverpool’s goalkeeping coach.


There is much to consider here and let me throw in something from this morning’s data which will not help. From the ECB.

The annual growth rate of the narrower aggregate M1, which includes currency in circulation
and overnight deposits, decreased to 7.0% in April, from 7.5% in March.

Another hint of an economic slow down albeit broad money was a little better. Moving to the financial crisis this will be felt by individual Italians as they are savers and for example around 64% of Italian debt is held by domestic hands. So they are losing and whilst overseas investors are in a minority that is still some 685 billion Euros due to the size of the market. Thanks to the Bruegel group for the data. This is of course before we get to the stock market and those holding bank debt. Remember when we were told what great deals the bank debt was? Also the “protecting savers” part from President Mattarella not only goes into my financial lexicon for these times but will be part of what historians will call the Mattarella Error.

As a final though this has answered a question we have been asking for a while. What would get the Euro to fall? This has been answered as we note it has dropped to 1.15 and a bit versus the US Dollar and even the UK Pound £ has nudged a little higher to the nearly the same number.




How soon will the US national debt be unaffordable?

It is time to look again at a subject which has been a regular topic in the comments section. This is what happens when national debt costs start to rise again? We have spent a period where rises in national debts have been anesthetized by the Quantitative Easing era where central bank purchases of sovereign debt have had a side effect of reducing debt costs in some cases by very substantial amounts. Of course  it is perfectly possible to argue that rather than being a side effect it was the real reason all along. Personally I do not think it started that way but once it began like in some many areas establishment pressure meant that it not only was expanded in volume but that it has come to look in stock terms really rather permanent or as the establishment would describe it temporary. Of the main players only the US has any plan at all to reduce the stock whereas the Euro area and Japan continue to pile it up.

So let us take a look at projections for the US where the QE flow effect is now a small negative meaning that the stock is reducing. Here is Businessweek on the possible implications.

Over the next decade, the U.S. government will spend almost $7 trillion — or almost $60,000 per household — servicing the nation’s massive debt burden. The interest payments will leave less room in the budget to spend on everything from national defense to education to infrastructure. The Congressional Budget Office’s latest projections show that interest outlays will exceed both defense discretionary spending and non-military discretionary spending by 2025.

The numbers above are both eye-catching and somewhat scary but as ever this is a case of them being driven by the assumptions made so let us break it down.

US National Debt

It is on the up and up.

Debt held by the public, which has doubled in the past
10 years as a percentage of gross domestic product
(GDP), approaches 100 percent of GDP by 2028 in
CBO’s projections.

Those of you who worry we may be on the road to World War III will be troubled by the next bit.

That amount is far greater than the
debt in any year since just after World War II

As you can see the water has got a bit muddled here as the CBO has thrown in its estimates of economic growth and debt held by the public so let us take a step back. It thinks that annual fiscal deficits will rise to above US $1 Trillion a year in this period meaning that from now until 2028 they will total some US $12.4 billion. That will put the National Debt on an upwards path and the amount held by the public will be US $28.7 Trillion. Sadly they skirt the issue of how much the US Federal Reserve will own so let us move on.


These have become more of an issue simply because the CBO thinks the recent Trump tax changes will raise the US fiscal deficit. The over US $1 Trillion a year works out to around 5% of GDP per annum.

Bond Yields

These are projected to rise as the US Federal Reserve raises its interest-rates and we do here get a mention of it continuing to reduce its balance sheet and therefore an implied reduction in its holdings of US Treasury Bonds.

Meanwhile, the interest rate on 10-year Treasury notes increases from its average of 2.4 percent in the latter part of 2017 to 4.3 percent by the middle of 2021. From 2024 to 2028, the interest rate on 3-month Treasury bills averages
2.7 percent, and the rate on 10-year Treasury notes,
3.7 percent.

Currently the 10-year Treasury yield is 2.83% so the forecast is one to gladden the heart of any bond vigilante. If true this forecast will be a major factor in rising US debt costs over time as we know there will be plenty of new borrowing at the higher yields. But here comes the rub this assumes that these forecasts are correct in an area which has often been the worst example of forecasting of all. For example the official OBR forecast in the UK in a similar fashion to this from the CBO would have UK Gilt yields at 4.5% whereas in reality they are around 3% lower. That is the equivalent of throwing a dart at a dartboard and missing not only it but also the wall.


This comes into the numbers in so many ways. Firstly the US does have inflation linked debt called TIPS so higher inflation prospects cost money. But as they are around 9% of the total debt market any impact on them is dwarfed by the beneficial impact of higher inflation on ordinary debt. Care if needed with this as we know that price inflation does not as conventionally assumed have to bring with it wage inflation. But higher nominal GDP due to inflation is good for debt issuers like the US government and leads to suspicions that in spite of all the official denials they prefer inflation. Or to put it another way why central banks target a positive rate of consumer inflation ( 2% per annum) which if achieved would gently reduce the value of the debt in what is called a soft default.

The CBO has a view on real yields but as this depends on assumptions about a long list of things they do not know I suggest you take it with the whole salt-cellar as for example they will be assuming the inflation target is hit ignoring the fact that it so rarely is.

In those years, the real interest rate on
10-year Treasury notes (that is, the rate after the effect of
expected inflation, as measured by the CPI-U, has been
removed) is 1.3 percent—well above the current real rate
but more than 1 percentage point below the average real
rate between 1990 and 2007.

Economic Growth

In many ways this is the most important factor of all. This is because it is something that can make the most back-breaking debt burden suddenly affordable or as Greece as illustrated the lack of it can make even a PSI default look really rather pointless. There is a secondary factor here which is the numbers depend a lot on the economic impact assumed from the Trump tax cuts. If we get something on the lines of Reaganomics then happy days but if growth falters along the lines suggested by the CBO then we get the result described by Businessweek at the opening of this article.

Between 2018 and 2028, actual and potential real output
alike are projected to expand at an average annual
rate of 1.9 percent.

The use of “potential real output” shows how rarefied the air is at the height of this particular Ivory Tower as quite a degree of oxygen debt is required to believe it means anything these days.


The issue of the affordability forecast is mostly summed up here.

CBO estimates that outlays for net interest will increase
from $263 billion in 2017 to $316 billion (or 1.6 percent
of GDP) in 2018 and then nearly triple by 2028,
climbing to $915 billion. As a result, under current law,
outlays for net interest are projected to reach 3.1 percent
of GDP in 2028—almost double what they are now.

This terns minds to what might have to be cut to pay for this. However let me now bring in what is the elephant in this particular room, This is that if bond yields rise substantially pushing up debt costs then I would expect to see QE4 announced. The US Federal Reserve would step in and start buying US Treasury Bonds again to reduce the costs and might do so on a grand scale.. Which if you think about it puts a cap also on its interest-rate rises and could see a reversal. Thus the national debt might remain affordable for the government but at the price of plenty of costs elsewhere.





What does the 10 year yield of Greece tell us?

Today’s headline or title introduces a subject which I find both frustrating and annoying.This is not only because it regularly misunderstood but also because it represents something of a financialisation of the human experience. What I mean by that is that some have used it as a way of suggesting an improvement in Greek economic performance that does not exist. Personally I sometimes wonder if it is used because it is the one signal that does show a clear improving trend. Let me illustrate with this from the LSE European Politics blog this morning.

A fall like that looks good on the face of it. Few point out the irony which is that falls in bond yields like that used to mean that a country was heading into at best a recession and probably a depression. Actually a drop from around 10% to around 4% indicates that something may be wrong so let us investigate.

The Greek bond market

A troubling sign arrives when we look for the benchmark 10 year bond of Greece and see that the benchmark page at the Hellenic Republic debt agency or PDMA is “under construction”. If we look at the data at the end of 2017 we see that of total debt of 328.7 billion the total of bonds is around 50.4 billion and if we add in treasury bills and the like we get to 65.4 billion.

By comparison the European Stability Mechanism or ESM tells us this.

The loan packages from the ESM and EFSF are by far the largest the world has ever seen. The two institutions own half of Greece’s debt.

Actually the support for Greece totals some 233 billion Euros which means we need to add the IMF and the original Greece “rescue” package to the numbers above.

Oh and as to the bond total well there is still the SMP which sounds like something used in the Matrix series of films but is in fact the Securities Markets Program which has mostly been forgotten but still amounts to 85 billion Euros. These days that is I guess a balancing item in the ECB accounts but it does appear here and there.

The ECB’s interest income from its SMP holdings of Greek government bonds amounted to €154 million (2016: €185 million).

There was a time that the SMP was a big deal and regular readers will recall so was its “sterilisation” but the ECB got bored with that in 2014 and gave up. Oh well!

But if we move on we see that there are relatively few Greek bonds around and of those that do exist the ECB holds a fair bit.

Why has the bond yield fallen then?

You could argue that the bond yield should have fallen before. A possible reason for it not doing so is that it is now too small a market for big hedge funds to bother with, especially if we note that a busy month now for the market (December) had a volume of 120 million Euros. But if we look from now there have been changes in the bond metrics. For example the average maturity of Greek bonds has risen mostly by the fact that ESM loans have an average maturity of 32 years. Also bond investors may have noticed a certain “To Infinity! And Beyond” willingness from the ESM and added that to the overall bond maturity of 18.32 years.

Fiscal Matters

The LSE blog summarises matters like this.

Greece has outperformed Programme budget targets . According to the Hellenic Fiscal Council, Greece may have reached a 3.5% primary surplus in 2017 already, versus a target of 1.75%. There are reasons to be optimistic about Greece meeting the fiscal targets in 2018 as well. Maintaining a 3.5% primary surplus also in the years to come appears feasible. On balance, the overall improvement of the fiscal situation is impressive.

From a bond investor’s point of view this if combined with the extended average maturity looks more than impressive as it means on their metrics the thorny issue of repayment has been kicked into the future. They will also like this statement from the ESM on the 27th of March.

 Today the Board of Directors of the European Stability Mechanism (ESM) approved the fourth tranche of €6.7 billion of ESM financial assistance for Greece. …….The tranche will be used for debt service, domestic arrears clearance and for establishing a cash buffer.

Problems in the real economy

There is a very descriptive chart in the LSE blog.

This shows us that the initial credit crunch impact on Greece was what we might call Euro area standard. But those of a nervous disposition might want to take the advice of BBC children’s programming from back in the day and look away now from the real crisis. Here we saw “shock and awe” but not of the form promised by Christine Lagarde which back then was France’s Finance Minister. An attempt to achieve the fiscal probity so approved of by bond markets saw the economy plunge into quite a recession and made an already bad situation worse. But the rub is that the recovery such as it is was not the “V-shaped” bounce back you might expect but rather this.

However, not only is there no indication of any catching up following the crisis, but also the pace of growth remains below the Eurozone’s.

So whilst we now have some growth there has been no relative recovery and in fact on that metric things have got worse. This comes in spite of the “Grecovery” theme of around 2013 which was an example of what we now call Fake News and of course was loved by the Euro area establishment. The reality is not only did thy make the recession worse they seem to have managed to prevent a bounce back as well. We can bring this up to date with the latest business survey for Greek manufacturing.

At 55.0, the index reading signalled a
marked rate of growth, albeit one that was weaker
than the multi-year high seen in February (56.1).

I am pleased to see that but you see that is slightly worse than what the UK did in March. I will not tire you with the different themes and descriptions in the media but simply say I am sad for Greece and  its people and use the famous words of Muhammad Ali.

Is that all you’ve got George?


If we step back we can see the impact of what is called “internal competitiveness” or if you prefer squeezing real wages. Let us look at that a different way as the UK had some of this albeit not as much. But the measure here we gives us a scale of the disaster is unemployment which has got better in Greece but comparing an unemployment rate of 20.8% with one of 4.3% is eloquent enough I think.

It also gives us an easy cause of this issue raised by the LSE.

Direct tax revenues are not performing very well. The high rate of social contributions has probably increased the area of tax evasion.

Also I am reminded that the IMF has failed in an area it mostly used to be successful in.

The external position has improved sharply, although more because of weakness in domestic demand than strength in export activity. Export performance remains underwhelming.

You see on that performance any improvement will simply put Greece back into balance of payments problems which is sort of where we came in. Also there is this from the Bank of Greece.

On 8 March 2018 the Governing Council of the ECB did not object to an ELA-ceiling for Greek banks of €16.6 billion, up to and including Wednesday, 11 April 2018, following a request by the Bank of Greece.

The reduction of €3.2 billion in the ceiling reflects an improvement of the liquidity situation of Greek banks, taking into account flows stemming from private sector deposits and from the banks’ access to wholesale financial markets. 

So it has got better but it has yet to go away.

Thus in summary we see that we have seen something of a divorce between the Greek financial and real economies. Prospects for the bond market look good but the real economy has not done much more than stop falling with a lot of ground still to be reclaimed. Those who look at credit conditions will not be reassured by this from the LSE blog.

 According to the Bank of Greece, the annual growth rate of credit to the private sector stood at -1.0% in February, and that of credit to corporations at 0.2%.

There was a time when the supporters and acolytes of the Euro area “shock and awe” package accused me and others who were in the default and devaluation camp of being willing to collapse the economy so let me finish with some Michael Jackson.

Remember the time
Remember the time
Do you remember, girl
Remember the time



Is Greece growing more quickly than the UK?

Today we return to a long running and grim saga which is the story of Greece and its economic crisis. However Bloomberg has put a new spin on it as follows.

Greece is growing faster than Britain and is outperforming it in financial markets.

Okay so let us take a deeper look at what they are saying. Matthew Winkler who is the Editor-in-Chief Emeritus of Bloomberg News, whatever that means, goes on to tell us this.

In a role reversal not even the most prescient dared to anticipate, Greece is growing faster than the U.K. and outperforming it in financial markets. ……..Now that Europe is leading the developed world in growth, productivity and job creation after the euro gained 14.2 percent last year — the most among 16 major currencies and the strongest appreciation since 2003 — Greece is the biggest beneficiary and Britain is the new sick man of Europe.

This is really quite extraordinary stuff isn’t it? Let me just mark that the author seems to be looking entirely through the prism of financial markets and look at what else he has to say.

In the bond market, Greece is the king of total return (income plus appreciation), handing investors 60 percent since the Brexit vote. U.K. debt securities lost 3 percent, and similar bonds sold by euro-zone countries gained 7 percent during the same period, according to the Bloomberg Barclays indexes measured in dollars. Since March 1, 2012, when the crisis of confidence over Greece was at its peak and its debt was trading at 30 cents on the dollar, Greek bonds have returned 429 percent, dwarfing the 19 percent for euro bonds and 10 percent for the U.K., Bloomberg data show.

Also money is flowing into the Greek stock market.

ETF flows to Europe gained 15 percent and 13 percent to the U.K. during the same period. The Global X MSCI Greece ETF, the largest U.S.-based exchange-traded fund investing in Greek companies, is benefiting from a 35 percent increase in net inflows since the 2016 Brexit vote.

Finally we do actually get something based on the real economy.

The same analysts also forecast that Greece will overtake Britain in GDP growth. They expect Greece to see its GDP rise 2.15 percent this year and 2.2 percent in 2019 as the U.K. grows 1.4 percent and 1.5 percent.

Many of you will have spotted that the Greece is growing faster than the UK has suddenly morphed into people forecasting it will grow quicker than it! This poses a particular problem where Greece is concerned and can be illustrated by the year 2012. Back then we had been assured by the Troika that the Greek economy would grow by 2% on its way to an economic recovery and the UK was back then enmeshed in “triple-dip” fears. Actually there was no UK triple dip and the Greek economy shrank by around 7% on the year before.

GDP growth

According to the Greek statistics office these are the latest figures.

The available seasonally adjusted data
indicate that in the 3rd quarter of 2017 the Gross Domestic
Product (GDP) in volume terms increased by 0.3% in comparison with the 2nd quarter of 2017, while in comparison with the 3rd quarter of 2016, it increased by 1.3%.

Thus we see that if we move from forecasts and rhetoric to reality Greece has some economic growth which we should welcome but not only is that slower than the UK in context it is really poor if we look at its record. After the severe economic depression it has been through the economy should be rebounding rather than edging forwards. I have written many times that it should be seeing sharp “V Shaped” growth rather than this “L Shaped” effort.

If we look back the GDP at market prices peaked in Greece in 2008 at 231.9 billion Euros but in 2016 it was only 175.9 billion giving a decline of the order of 24% or 56 billion Euros. That is why it should be racing forwards now to recover at least part of the lost ground but sadly as I have predicted many times it is not. Even if the forecasts presented as a triumph above come true it will be a long long time before Greece gets back to 2008 levels. Whereas the UK economy is a bit under 11% larger and to be frank we think that has been rather a poor period.

Job creation

You may note that there was a shift to Europe leading the world on job creation as opposed to Greece so let us investigate the numbers.

The number of employed persons increased by 94,071 persons compared with November 2016 (a 2.6% rate of increase) and decreased by 9,659 persons compared with October 2017 (a 0.3% rate of decrease).

I am pleased to see that the trend is for higher employment albeit there has been a monthly dip. Actually if we look further the last 3 months have seen a fall so let us hope we are not seeing another false dawn. Further perspective is provided by these numbers.

The seasonally adjusted unemployment rate in November 2017 was 20.9% compared to the upward revised 23.3% in November 2016 and the upward revised 20.9% in October 2017. The number of employed in November 2017 amounted to 3,761,452 persons. The number of unemployed amounted to 995,899 while the number of inactive to 3,242,383.

The first issue is the level of unemployment which has improved but still has the power to shock due to its level. The largest shock comes from a youth unemployment rate of 43.7% which is better than it was but leaves us mulling a lost generation as some seem set to be out of work for years to come and maybe for good. Or perhaps as Richard Hell and the Voidoids put it.

I belong to the Blank Generation, and
I can take it or leave it each time.

Before I move on I would just like to mark the level of inactivity in Greece which flatters the numbers more than a little.

Bond Markets

Last week there was a fair bit of cheerleading for this. From the Financial Times.

Greece has wrapped up the sale of a seven-year bond after a 48-hour delay blamed on international market turbulence, raising €3bn at a yield of 3.5 per cent. The issue marked the first time since 2014 that the country has raised new money. A five-year bond issue last July raised €3bn, about half of which involved swapping existing debt for longer-dated paper.

The problem is in the interest-rate as Greece has got the opportunity to borrow at a much higher rate than it has been doing! Let me hand you over to the European Stability Mechanism or ESM.

The loans, at very low-interest rates with long maturities, are giving Greece fiscal breathing space to bring its public finances in order……..Moreover, the EFSF and ESM loans lead to substantially lower financing costs for the country. That is because the two institutions can borrow cash much more cheaply than Greece itself, and offer a long period for repayment.

As you can see the two narratives are contradictory as we note Greece is now choosing to issue more expensively at a considerably higher interest-rate or yield. This matters a lot due to its circumstances.

They point to the debt-to-GDP ratio, which stands at more than 180%.


I would be more than happy if the Greek economy was set to grow more quickly than the UK as frankly it not only needs to be growing much faster it should be doing so for the reason I explained earlier. As someone who has consistently made the case for it needing a default and devaluation I find it stunning that the Bloomberg article claims this is a success for Greece.

 the euro gained 14.2 percent last year — the most among 16 major currencies and the strongest appreciation since 2003

After all the set backs for Greece and its people what they do not need is a higher exchange rate. Finally the better prospects for the Euro area offer some hope of better days but they will be braked somewhat by the higher currency.

The confused narrative seems to also involve claiming that paying more on your debt is a good thing. Awkward in the circumstances to be making the case for sovereignty! But the real issue is to get out of this sort of situation which is sucking demand out of the economy. From Kathimerini.

 It is no coincidence that the “increased post-bailout monitoring” is expected to end in 2022, when the obligation for high primary surpluses of 3.5 percent of gross domestic product expires.

So in conclusion there is a lot to consider here as we wish Greece well for 2018. It badly needs a much better year but frankly also more considered and thoughtful analysis as those who have suffered through this deserve much better. The ordinary Greek was mostly unaware of what their establishment was doing as it fiddled the data and let the oligarchs slip slide away from paying their taxes.