The Italian Situation

 
I thought it would be worth explaining Wednesday night’s Italian situation.

Italian 10 year bonds hit 7.48% on Wednesday night our time which is what it costs the Government to borrow money.  Yes thats right we can get a fixed rate as an Australian with a job that is lower than that. Industry consensus is that levels >7% are unsustainable.

This marks their highest yield level since Italy joined the Euro which was when the ‘Eurozone’ was formed in 1999.

Market turmoil was exacerbated by LCH.Clearnet (London Clearing House) increasing costs of margins for those traders participating in trading Italian bonds. This is rational behaviour on behalf of LCH.Clearnet. CME has done this a number of times in the past 12 months for both Gold and Silver futures margins. This happens when volatility increases in the underlying instruments.

Bear in mind that the IMF has forecast Italian GDP growth for 2012 to be 0.3%.
Italy has a debt to GDP ratio of 120%.
They have EUR 1.9 Trillion of debt outstanding, the third highest in the world after the US and Japan. Yes, quite outstanding.
10 year bonds hit 7.4%, up 6.5% last week.

In order to calm markets, the ECB needs to continue to publicly proclaim that it will intervene in the secondary debt markets and continue to purchase Italian debt, thereby driving the yields down, for “as long as it takes”. This should assuage markets somewhat, but still does not detract from the enormity of the role that faces the impending new Italian PM. Of course if the ECB, now headed by the freshly minted Mario Draghi (who is an Italian), will be purchasing all this debt itself. This creates inflationary pressures in years ahead. The Fed itself currently “owns” 30% of total US debt outstanding. The ECB, should they walk down the indefinite intervention path, will repeat this behaviour.

We now watch French yields.