The ECB and its Italian and Turkish problems

At the moment the European Central Bank (ECB) Governing Council is on its summer break and does not formally reconvene until the 13th of September. So I raised a wry smile when Bloomberg assured us ” The ECB is staying calm amid Turkey and Italy routs” this morning! The world does not stand still during summer and is showing more than a few signs of upset for the ECB so let us take a look.

Turkey

The very volatile nature of Turkish financial markets is an issue for the ECB and one signal of this is how such a nearby country can have such a different official interest-rate. The Turkish central bank after hints of a new 19.25% interest-rate in the melee of Monday has remained at 17.75% which is an alternative universe to the -0.4% deposit rate of the ECB. It is hard to believe Greece and Turkey are neighbours when you look at that gap.

Next comes the exchange rate where at the start of 2018 some 4.55 Turkish Lira were required to buy one Euro as opposed to the 6.72 required as I type this. Even that is a fair retracement of the surge which saw it just fail to make 8 only on Monday. Apart from being a dizzying whirl recently we can see that the fall this year must have made trade difficult. As to how much trade there is we need to switch to the European Union about which we were told this in April.

  • In 2017, among the EU’s trading partners, Turkey was the fifth largest partner for exports from the EU and the sixth largest partner for imports to the EU.
  • The EU’s trade surplus with Turkey has fallen from a peak of EUR 27 billion in 2013 to EUR 15 billion in 2017.
  • Manufactured goods make up 81 % of EU exports to Turkey and 89 % of EU imports from Turkey.
  • In 2017, Germany was the EU’s largest import (EUR 14 billion) and export (EUR 22 billion) partner with Turkey.
  • Germany also had the largest trade surplus (EUR 8 billion) with Turkey while Slovenia had the largest deficit (EUR 1.5 billion).

If we just switch to exports then we see the importance of Turkey.

Germany was also the largest exporter (EUR 21.8 billion) to Turkey followed by Italy (EUR 10.1 billion) and the United Kingdom (EUR 8.4 billion). Almost a quarter of Bulgaria’s extra-EU exports (23 %) were destined for Turkey. Greece (15 %) and Romania (14 %) also had high shares while all other Member States had shares below 9 %.

Of course some of those countries are not the responsibility of the ECB but we do get an idea of vulnerabilities such as the ability of Turkish consumers to buy German cars. Also Italy with its own economic issues that I will come on to later can do without any fall in exports. Even worse for Greece.

Right in the ECB’s orbit however was this from the Financial Times last week about risks to the “precious”.

The eurozone’s chief financial watchdog has become concerned about the exposure of some of the currency area’s biggest lenders to Turkey — chiefly BBVA, UniCredit and BNP Paribas — in light of the lira’s dramatic fall…….Spanish banks are owed $82.3bn by Turkish borrowers, French banks are owed $38.4bn and Italian lenders $17bn in a mix of local and foreign currencies. Banks’ Turkish subsidiaries tend to lend in local currency.

There have been arguments since then as to exactly the size of the risk but it is clear that there is an issue. Of course if we bring the exchange-rate back in it looks much less at 6.7 to the Euro than it did at 8 but to any proper analysis that move this week may well be as dangerous as the fall. Looked at through the eyes of an ex-option trader (me) you see that a short derivative position might have been hedged in the panic ( so towards 8) but the catch is that you would be long the Euro up there just in time for it to drop! So you lose both ways. We never really find out about this sort of thing until it has really badly gone wrong.

Italy

In a way much of the problem here has been exemplified by the dreadful Autostrada bridge collapse. For a start how does that happen in a first world country? Then even worse everyone seems to be blaming everyone else. If we move to the direct beat of th ECB there is the ongoing economic growth issue.

In the second quarter of 2018 Italian economy slowed down, as suggested in the previous months by the leading indicator. The GDP quarterly slightly decelerated (+0.2% compared to +0.3% Q1,)

That brings Italy back to my long running theme that it struggles to have economic growth above 1%. Indeed as this still represents a period where monetary policy was very expansionary there will be fears for what will happen as it gets wound back.

On the latter subject of reducing and then an end to the QE program there was this on Monday.

The economic spokesman of Italy’s ruling League party warned on Monday that unless the European Central Bank offers a guarantee to cap yield spreads in the euro zone, the euro will collapse………….Borghi said the ECB should guarantee that yield spreads between euro zone government bonds not exceed a certain level, suggesting 150 basis points between the yields of any two sovereign bonds as a reasonable maximum. ( Reuters)

That sort of statement opens more than one can of worms. The simplest is just to compare that with where we are which is 284 basis points or 2.84%. So he is looking for the ECB to back stop the Italian bond market and his own spending plans a subject which has arisen before. No doubt this is driven by the rise in the ten-year yield of Italy which is now 3.14% which is not historically high but since then Italy’s national debt and therefore borrowing needs has risen meaning that matters tighten at lower yields than they used to.

Next comes the fact that even the ECB which in spite of calling itself a “rules based organisation” has operated at least to some extent by making them up as it goes along. But a programme just to help Italy would be even nearer to overt monetary financing than what we have seen so far. Other nations taxpayers would wonder why it was being singled out for favourable treatment. This would be especially true in Greece which only a week ago found that a waiver for its collateral at the ECB had ended.

Greek banks borrow just over 8 billion from the ECB in longer-term refinancing operations and now need to post a new type of collateral to maintain their access. ( Reuters)

Meanwhile there is the ongoing issue of the Italian banks and the irony of the Turkish situation is the way that Unicredit which was supposed to be escaping the noose may have found a way of putting its neck back in it.

Comment

Having looked at particular issues it is time to bring the analysis back to the day job which is monetary policy. This morning brought troubling news for those who are in the “pump it up” camp.

The euro area annual inflation rate was 2.1% in July 2018, up from 2.0% in June 2018. A year earlier, the rate was
1.3%.

Thus it has for now achieved its inflation objective and in fact it is a little above the 1.97% indicated by the previous President Jean-Claude Trichet. So those wanting more only have the “core” or excluding energy number at 1.4% to support them. They can also throw in the fact that economic growth has slowed in 2018 but also have to face the issue that even Mario Draghi regards this as pretty much a normal level.

Seasonally adjusted GDP rose by 0.4% in both the euro area (EA19) and the EU28……..Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.2% in both the euro area and the EU28.

Thus the ECB moves forwards with its monetary policy locked on course. It has no intention of raising interest-rates and a cut would provoke questions as after all it has told us things are going well. The QE programme is being trimmed in flow terms and it will not be long before that stops. What it has now are the boring parts of central banking such as bank supervision but in the case of Euro area banks in Turkey that would look like closing the stable door long after the horse has bolted.

Of course it could intervene against the Turkish Lira to help provide some stability and to help Euro area exporters. But I think we all know it would only do that if it thought it would help the banks. Also if we take the example of right now and the fall to 6.91 versus the Euro whilst I have been typing this it would no doubt attract the attention of the Donald and his twitter feed plunging the ECB into a political morass.  Such thoughts will have Mario Draghi reaching for another glass of Chianti on his summer break.

 

 

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The economy of Italy returns to its former coma status

We are in a spell where there has been a burst of economic news about Italy and the headline brings back memories of my main theme. So let us take a look at why the idea of it being like a “girlfriend in a coma” is back.

In the second quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross
Domestic Product (GDP) increased by 0.2 per cent with respect to the first quarter of 2018 and by 1.1 per
cent in comparison with the second quarter of 2017. ( ISTAT)

Along the way I note that the statement below from only last week of European Central Bank President Mario Draghi does not seem to apply that well to his home country.

 the euro area economy is proceeding along a solid and broad-based growth path.

For newer readers my “girlfriend in a coma” theme comes from the fact that for quite some time now Italy has struggled to grow its economy at more than 1% per annum. So a fall to 1.1% reminds us of that especially as we note that annual growth only got as high as 1.7% in the “Euroboom” and since then has gone 1.6%,1.4% and now 1.1%. If we switch to the quarterly numbers then the trend is clearly not our friend as the peak of 0.5% at the end of 2016 was held in the opening quarter of 2017 but has since gone 0.4%, 0.3%,0.3%,0.3% and now 0.2%. Indeed there has also been a downgrade of the past as we had two 0.4% previously.

Perspective

The tweet below sums up the overall theme where Italy is not only still well below its pre credit crunch peak but has grown so little this century or if you prefer in the Euro era.

Also Italy has seen a fair bit of population growth meaning that the numbers on an individual or per capita basis are even worse and I have been waiting for them to rise back to where they were at the beginning of this century. Unfortunately growth has slowed to a crawl but they should be somewhere around them now.

Labour Market

We have seen in the credit crunch era that employment trends can be a leading indicator for an economy but get little solace here either.

In June 2018, 23.320 million persons were employed, -0.2% over May

The picture had been improving as the 330000 jobs gain over the past year illustrates but now the picture is not so clear. If we switch to unemployment we see that the sense of unease increases.

Unemployed were 2.866 million, +2.1% over the previous month.

This meant that the annual picture here was of only a fall of 8000 in the ranks of the unemployed. Also I have pointed out before that the unemployment rate falls below 11% to media cheers and then climbs back up to it as if it is on repeat. Well it has not yet gone back to 11% but not far off it.

unemployment rate was 10.9%, +0.2 percentage points over May 2018

The disappointing picture continues when we look at the bugbear which is youth unemployment.

Youth unemployment rate (aged 15-24) was 32.6%, +0.5 percentage points over the previous month and
youth unemployment ratio in the same age group was 8.6%, +0.2 percentage points over May 2018.

Inflation

If we switch to the other component of what used to be called the Misery Index ( where the annual rate of inflation was added to the unemployment rate) we see this.

In July 2018, according to preliminary estimates, the Italian harmonised index of consumer prices (HICP) decreased by 1.4% compared with the previous month and increased by 1.9% with respect to July 2017 (from +1.4% in June).

So the Misery Index rose to 12.8% if we use the latest figures albeit that unemployment is for June and not July. Just for clarity the HICP above is the measure we use in the UK as Italy kept the CPI moniker for its own measure. Some of the inflation rise was due to the summer sales starting a week later than in 2017.

Wages

There was better news here but it comes with a bit of a kicker. So let us start with the good news.

In June 2018 the hourly index and the per employee index increased by 0.9 per cent from last month.

Compared with June 2017 both indices increased by 2.0 per cent.

That was something of a burst and meant that there was some real wage growth and the numbers cover a lot of the economy.

At the end of June 2018 the coverage rate (share of national collective agreements in force for the wage setting aspects) was 86.8 per cent in terms of employees and 87.4 per cent in terms of the total amount of wages.

In fact wage growth for most changed very little but it rose to an annual rate of 4% in the public administration sector driven by a 6.4% rise for the military and 6.1% for the police. Well I suppose that is one way of boosting defence spending to please President Trump! But returning to the economics we see that whilst higher wages in that sector should boost areas such as retail sales the ordinary Italian taxpayer may be nervous of higher taxes to pay for it. Also is it ominous that the government is seemingly getting the police and military onside?

Looking Ahead

This mornings private-sector survey or PMI for the manufacturing sector did not start well.

Manufacturing growth eases in July to lowest since October 2016

The detail in fact questioned whether there was any growth at all.

Growth rates of both output and new orders
weakened during July to near standstills amid
reports of an ongoing slowdown in underlying
market activity. There were reports that both
domestic and external market conditions were
faltering. Indeed, new export orders rose to the
weakest degree since August 2016 according to the
latest data.

Indeed the conclusion was downbeat when we try to add this report to the overall picture.

Based on the latest set of PMI survey data, and
with worries mounting over any escalation of global
trade tensions on export trade, Italy’s industrial
base may well struggle to meaningfully contribute to
wider economic growth in the second half of 2018

Comment

There is a familiar drumbeat about all of this as we see Italy slipping back into what is normal for it. For a start there is the still very expansionary monetary policy of the ECB with its -0.4% deposit rate although the monthly QE purchases are reducing which drives the thought that even at its height Italy gained only a little. Economic growth since the beginning of 2014 totals a mere 4.5%.

Next comes the issue of Italy’s high national debt which has risen above 2.3 trillion Euros and of course now faces higher bond yields  (ten-year is 2.76%) as it looks to refinance maturing debt and raise new finance. The essential issue here has not been one of overspending but much more one of lack of economic growth.

Italy is in many ways a delightful country so let us end with something more positive which I note from the purchase of Ronaldo by the grand old club Juventus. Like all football transfers it starts not so well as it the fee is an import and subtracts from GDP but more positively the hope is that he provides a boost via Champions League success. But I spotted something else. From CNBC.

Ronaldo fans can purchase children’s jerseys with his name for €84.95 ($98.90), women’s jerseys for €94.95 ($110.60), men’s jerseys for €104.95 ($122.20) and an authentic replica of the gear worn by Juventus playersfor €137.45 ($160.10).

There is a lot of poor analysis on this sort of thing as much of the money goes nowhere near Juve but my point is there must be money in Italy if Juve can charge that much for a football shirt. Of course there will be international fans buying but also plenty of Italian ones.

 

 

 

 

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.

ROSSI SAYS YIELD SPREAD WIDER DUE TO -EXIT RISK: ANSA || brilliant…

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.

A GRADUAL RISE IN INTEREST RATES TO PRE-CRISIS LEVELS IS NOT A CAUSE FOR CONCERN FOR ITALY -BANK OF ITALY OFFICIAL ( @DeltaOne )

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.

Comment

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.

 

 

 

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
Italy.

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.

Comment

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.

Poverty

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.

Comment

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.

 

 

 

The Italian economic job has led us to the current mess

After looking at the potential plans of the new Italian coalition government, assuming it gets that far yesterday let us move onto the economic situation. Let us open with some news from this morning which reminds us of a strength of the Italian economy. From Istat.

The trade balance in March 2018 amounted to +4.5 billion Euros (+3.8 billion Euros for non EU area and +0.7
billion Euros for EU countries).

There is an immediate irony in having joined a single currency ( Euro ) to boost trade and find that your main surplus is elsewhere. However some 55.6% of trade is with the European Union and 44.4% outside so there is a sort of balance if we note we are not being told the numbers for the Euro area itself. If we do an annual comparison then it is not a good day for economics 101 either as the relatively strong Euro has not had much of an effect at all as the declines are mostly within the European Union.

Outgoing flows fell by 2.2% for non EU countries and by 1.5% for EU countries. Incoming flows increased by 0.4% for EU area and decreased by 0.5% for non EU area.

Actually both economic theory and Euro supporters will get some more cheer if we look at the year so far for perspective as exports with the EU ( 5.5%) have grown more quickly than those outside it (0,5%). The underlying picture though is of strength as in the first quarter of 2018 a trade surplus of 7.5 billion Euros has been achieved. If we look back and use 2015 as a benchmark we see that exports are at 114.1 and imports at 115.9 so Italy is in some sense being a good citizen as well by importing.

The main downside is that Italy is an energy consumer ( net 9.4 billion Euros in 2018 so far) which is not going to be helped by the current elevated oil price.

Inflation

This is an intriguing number as you might think with all the expansionary monetary policy that it was a racing certainty. But reality as so often is different. If we look at the trading sector we see this.

In March 2018 the total import price index decreased by 0.1 % compared to the previous month ; the total twelvemonth
rate of change increased by 1.0%.

So quite low and this is repeated in the consumer inflation data series.

In April 2018, according to preliminary estimates, the Italian harmonised index of consumer prices (HICP) increased by 0.5% compared with March and by 0.6% with respect to April 2017 (it was +0.9% in the previous month).

Just for clarity that is what we call CPI in the UK and is not called that in Italy because it has its own measure already called that. Apologies for the alphabetti spaghetti. Such a low number was in spite of a familiar influence in March.

The increase on monthly basis of All items index was mainly due to the rises of prices of Non-regulated energy products (+1.1%) ( from the CPI breakdown).

Although there was also a reduction in regulated energy prices. But in essence the theme here is not much and personally I welcome this as I think that driving inflation up to 2% per annum would be likely to make things worse if we note the sticky nature of wage growth these days.

If we move to an area where we often see inflation after expansionary monetary policy which is asset prices we again see an example of Italy being somewhat different.

According to preliminary estimates, in the fourth quarter of 2017: the House Price Index (IPAB) increased by 0.1% compared with the previous quarter and decreased by 0.3% in comparison to the same quarter of the previous year (it was -0.8% in the third quarter of 2017);

The numbers are behind the others we have examined today but the message is loud and clear I think. Putting it another way Mario Draghi is I would imagine rather disappointed in the state of play here as it would help the struggling Italian banks by improving their asset base especially as such struggles draw attention to the legal basis for them known as the Draghi Laws which have been creaking.

Growth

The good news is that there is some as you see there is a case to be made that the trend rate of growth for Italy is zero which is not auspicious to say the least.

In the first quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross
Domestic Product (GDP) increased by 0.3 per cent with respect to the fourth quarter of 2017 and by 1.4 per
cent in comparison with the first quarter of 2017.

If we stick with what Chic might call “Good Times” then Italy beat the UK and drew with Germany and France in the quarter just gone. However it was more their woes than Italian strength sadly as I note that even with this economic growth over the past four years has been 4.3%. This is back to my theme that Italy grows at around 1% per annum in the good times that regular readers will be familiar with and the phrase girlfriend in a coma. Less optimistic is how quarterly GDP growth has gone 0.5% (twice), 0.4% (twice) and now 0.3% (twice).

Labour Market

Here is where we get signs of real “trouble,trouble,trouble” as Taylor Swift  would say.

unemployment rate was 11.0%, steady over February 2018…..Unemployed were 2.865 million, +0.7% over the previous month.

The number has fallen by not by a lot and is still a long way above the 6-7% of the pre credit crunch era. So whilst it is good news that 190,000 more Italians gained jobs over the preceding 12 months that is very slow progress. Also wage growth seems nothing to write home about either.

At the end of March 2018 the coverage rate (share of national collective agreements in force for the wage setting aspects) was 65.1 per cent in terms of employees and 62.1 per cent in terms of the total amount of wages.

In March 2018 the hourly index and the per employee index increased by 0.2 per cent from last month.

Compared with March 2017 both indices increased by 1.0 per cent.

So a very marginal increase in real wages.

Comment

One thing that has struck me as I have typed this is the many similarities with Japan. Let me throw in another.

According to the median scenario, the resident population for Italy is estimated to be 59 million in 2045 and 54.1 million in 2065. The decrease compared to 2017 (60.6 million) would be 1.6 million of residents in 2045 and 6.5 million in 2065.

A clear difference can be seen in the unemployment rate and of course even Italy’s national debt is relatively much smaller although not as the Japanese measure such things.

The bond yield is somewhat higher especially after yesterday’s price falls and the ten-year yield is now 2.12% but here is another similarity from a new version of the proposed coalition agreement.

I imagine this would mean asking banks to hold less capital for the loans they give to SMEs. This would make banks more fragile and – in the 5 Star/League world – could lead to more “public gifts” to private banks. ( @FerdiGuigliano )

The Bank of Japan had loads of such plans and of course the Bank of England modified its Funding for Lending Scheme in this way too. Neither worked though.

Meanwhile we cannot finish without an apparent eternal  bugbear which is the banks.

League and 5 Star also have plans for Monte dei Paschi, which has been recently bailed out by the Italian government. They want to turn it into a utility, where the State (as opposed to an independent management) decides the bank’s objectives.

Me on Core Finance TV

 

 

Will Italy get a 250 billion Euro debt write-off from the ECB?

Up until now financial markets have been very sanguine about the coalition talks and arrangements in Italy. I thought it was something of calm before the storm especially as these days something which was a key metric or measure – bond yields – has been given a good dose of morphine by the QE purchases of the European Central Bank. However here is a  tweet from Ferdinando Guigliano  based on information from the Huffington Post which caught everyone’s attention.

1) Five Star and the League expect the to forgive 250 billion euros in Italian bonds bought via quantitative easing, in order to bring down Italy’s debt.

My first thought is that is a bit small as whilst that is a lot of money Italy has a national debt of 2263 billion Euros or 131.8% of its GDP or Gross Domestic Product according to Eurostat. So afterwards it would be some 2213 billion or 117% of GDP which does not seem an enormous difference. Yes it does bring it below the original 120% of GDP target that the Euro area opened its crisis management with but seems hardly likely to be an objective now as frankly that sank without trace. Perhaps they have thoughts for spending that sort of amount and that has driven the number chosen.

Could this happen?

As a matter of mathematics yes because the ECB via the Bank of Italy holds some 368 billion Euros and rising of Italian government bonds and of course rising. However this crosses a monetary policy Rubicon as this would be what is called monetary financing and that is against the rules and as we are regularly told by Mario Draghi the ECB is a “rules based organisation”. Here is Article 123 of the Lisbon Treaty and the emphasis is mine.

Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

Now we hit what Paul Simon would call “troubled water” as the ECB has of course been very close to the highlighted part. The argument for QE purchases rested on the argument that buying in the secondary market was indirect and not direct or as the ECB puts it.

There will be no primary market purchases under the PSPP, regardless of the type of security, as such purchases are not allowed under Article 123 of the Treaty on the Functioning of the European Union.

It is a bit unclear as to when they become available but if I recall correctly as an example the Bank of England limit is one week.

The reason for this is to stop a national government issuing debt and the central bank immediately buying it would be a clear example of round-tripping. The immediate implication would be a higher money supply raising domestic inflation dangers  although there would be an initial boost to the economy. We did look at an example of this a couple of years ago in the case of Ghana and whilst we never get a test tube example in economics the Cedi then fell a substantial amount and inflation rose . Thus the two worrying implications are inflation and a currency plunge on a scale to cause an economic crisis.

Would this happen in the case of Italy? That depends on how it plays out. Inside the boundaries of the Euro maybe not to a  great extent initially but as it played out there would be an effect as Italy would not doubt be back for “More,More,More” once Pandora’s Box was open and of course others would want to get their fingers in the cookie jar.

Oh and if we go back to the concept of the ECB being a “rules based organisation” that is something that is until it breaks them as we have learnt over time.

Fiscal Policy

You will not be surprised to learn that they wish to take advantage of the windfall. Back to the tweets of Ferdinando Guigliano

5) The draft agreement would see the Italian government spend 17 billion euros a year on a “citizens’ income”. The European Commission would contribute spending 20% of the European Social Fund

That raises a wry smile as we mull the idea of them trying to get the European Commission to pay for at least some of this. Perhaps they are thinking of the example of Donald Trump and his wall although so far that has been more of a case of a “Mexicant” than a “Mexican.”

Next came this.

According to , the 5 Star/League draft document says there would be a “flat tax”… but with several tax rates and deductions

So flat but not flat well this is Italy! Also we see what has become a more popular refrain in this era of austerity.

Italy’s pension reform would be dismantled: workers would be able to retire when the sum of their retirement age and years of contribution is at least 100.

Over time this would be the most damaging factor as we get a drip feed that builds and builds especially at a time of demographic problems such as an aging population.

So a fiscal relaxation which would require some changes in the rules of the European Union.

The two parties want to re-open European Treaties and to “radically reform” the stability and growth pact. The coalition would also want to reconsider Italy’s contribution to the EU budget.

Market Response

That has since reduced partly because the German bond market has rallied. Partly that is luck but there is an odd factor at play here. You might think that as the likely paymaster of all this Germany would see its bonds hit but the reality is that it is seen as something of a safe haven which outplays the former factor. On that road it issued some two-year debt yesterday with investors paying it around 0.5% per annum. Also I think there is such a shock factor here that it takes a while for the human mind to take it in especially after all the QE anaesthetic.

The Euro has pretty much ignored all of this as I use the rate against the Yen as a benchmark and it has basically gone “m’eh” as has most of the others so far.

Comment

There are quite a few factors at play here and no doubt there will be ch-ch-changes along the way. But the rhetoric at least has been raised a notch this morning.

We are in favor of a consultative referendum on the euro. It might be a good idea to have two euros, for two more homogeneous economical regions. One for northern Europe and one for southern Europe. ( Beppe Grillo in Newsweek)

I do not that the BBC and Bloomberg have gone into overdrive with the use of the word “populists” as I mull how you win an election otherwise? If we stick to our economics beat this is plainly a response of sorts to the ongoing economic depression in Italy in the Euro era. Also it was only on Monday when the Italian head of the ECB was asking for supra national fiscal policy. For whom exactly? Now we see Italy pushing for what we might call more fiscal space.

Meanwhile if we look wider we see yet more evidence of an economic slow down in 2018 so far.

Japan GDP suffers first contraction since 2015

Very painful for the Japanese owned Financial Times to print that although just as a reminder Japan is one of the worst at producing preliminary numbers.