Italian Mia Culpa - Big time!

by Bruce Krasting

I have written on a number of occasions over the past eighteen months that Italy was a “Core” country. Mine was a PIGS; it was not a PIIGS. It’s looking like I was wrong all along. The following slides tell the story. (Note: all prices have deteriorated since I got these graphs a few hours ago.)

This is the current 10-year. It was issued in February with a 4.75% coupon. It’s now pushing 94, so a year and a half’s worth of interest is thrown out the window. Can you say dog?

This is a seasoned bond. Notice that it lost 6% of its value since July 1. This is death to a global bond fund manager. They have to mark this dreck to market. (The banks don’t; ha ha!)

You might say, “Who cares about the stupid bondholders”. The problems are much deeper than that. Italy is being forced out of the Short Term capital markets as well. Look what has happened to six-month yields. If we are not at the crisis point, we are very close, based on this:

Italian equities have just collapsed of late. Down 23% in the past sixty days. How would you feel if the S&P took a dump like that? Answer: Your confidence would fall and that would bring about a recession. That is exactly what is happening in Italy today. It's happening at lightening speed:

If you are an Italian equity investor (and believe in the buy and hold) then this chart will really hurt. In the past few days we have taken out multi-year lows.

The very rapid pace of this proves one thing. I was not alone in thinking that Italy was an “insider”. A huge amount of money is being forced to rethink what is “safe” and what is not. That this is all happening in the middle of July is not helpful either. The whole country is about to go on holiday.

This last slide shows the pricing for all maturities of Italian debt. Note that there is only one issue trading above par. This is all credit spread deterioration. We are just a week or two before Italy gets locked out of the capital market. I’m not sure than any of the global markets are priced for that event.

Ambrose Evans-Pritchard at the Telegraph wrote about this today. I think he’s got it right.

Once again Europe's debt crisis has metastasized, and once again the financial authorities face systemic contagion unless they take immediate and dramatic action.

“Metastasized” is a horrible word. It’s fitting. I (now) doubt that the "immediate and drastic" action he suggests is needed is, in fact, going to happen. Gulp!

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