BTPs increasingly downloaded by investors around the world, the effect is there for all to see: rates on Italian government bonds splash above the 3% threshold for the first time since December 2018, with the spread BTP-Bund which is expanding to over 200. At the dawn of a new European sovereign debt crisis, as in 2011? That’s what he fears Maximilian Uleer, strategist at Deutsche Bankwho spoke in the last few hours about the risk of a “Euro Crisis 2.0?”warning that the debt burden in the euro area could return to 2011 levels should yields continue to rise.
The alert was reported by a MarketWatch article written by Steve Goldstein. On the other hand, the ingredients seem to be all there: Europe is grappling with an igalloping inflation also caused by the effects of the war in Ukraine, unleashed by Vladimir Putin’s Russia.
More and more members of the Governing Council of the ECB are recognizing the need to raise interest rates, starting the normalization of monetary policy that already sees the Fed and the Bank of England as protagonists. In the last few hours, a rate hike has been called for by the central bank led by Christine Lagarde in June.
Focus on the declarations issued by Olli Rehn, Governor of the Bank of Finland, central bank of Finland, and a member of the Governing Council of the ECB, who spoke of the “need to prevent that a further flare-up of inflation expectations it becomes rooted, eventually reflecting on the labor market “.
“In other words – Rehn said – we must prevent secondary effects from occurring. Consequently, in my opinion, we should move relatively quickly to get there a (rates) to zero and to continue our gradual process of monetary policy normalization. Obviously – underlined the banker – all this on condition that the war between Russia and Ukraine does not undergo a further escalation and does not intensify, to the point of derailing all our estimates and the recovery of the economy itself ”.
These words, combined with those of Francois Villeroy de Galhau, a member of the Governing Council of the European Central Bank, triggered the alert on the markets – already struggling with the Fed stress – putting economists to attention too.
The strategist of Deutsche Bank, in particular, pointed out that the levels of rates, both in absolute and relative terms, have increased since the 2011 sovereign debt crisismaking the comparison between the ten-year rates of the BTPs and those of the Bunds, and practically referring to the BTP-Bund spread, which rose to 200.
“Only in Germany and Ireland, where companies have moved to take advantage of lower taxes, debt-to-GDP ratios fell“. Sure, she admitted, “interest rates are lower, with the weighted average yield coming down significantly. The maturity of the debts is also longer “. However, this does not prevent Uleer from to fear new troubles for Italy and Spain in particular, countries that “run the greatest risk of seeing an increase in interest costs on GDP up to the levels of 2011”.
“The debt burden has dropped and the ECB has room to raise interest rates and to interrupt its purchase program – said the strategist – But the ECB’s margins of freedom are limited. And if rates continue to rise for an even longer period of time, we could find ourselves facing a Euro 2.0 Crisis ”.
A hawkish call in the last few hours has seen as a sender, in fact, too Francois Villeroy de Galhau, the governor of the central bank of France and another member of the Governing Council of the ECB, who said he would think it would be reasonable if euro area rates rose into positive territory (currently deposit rates are negative -0.50% ) before the end of the year.
The words of the two ECB officials have fueled the fear that Eurotower ends up raising rates three times this yearby 25 basis points (if the intention is to bring them back above zero, and not just zero).
The disposals on BTPs were triggered in the aftermath of the panic selling that knocked out Wall Street, triggered by the dual spectrum runaway inflation – fear of a recession in the USA and in the world – already feared according to a recent poll – the sell-offs hit the 50 basis point US rate hike announced by Jerome Powell’s Fed in the Day After, causing the Nasdaq to drop by -5% and the Dow Jones by over 1000 points.
The US stock market effect has spread throughout the world, with assets considered to be riskier which have paid for the climate of risk aversion, BTP first and foremost.
On the other hand, already yesterday the rates on tresuries, or the rates of government bonds made in the USA – traditionally considered safe assets – were once again breaking through the 3% threshold. It should come as no surprise, therefore, if the rates on ten-year BTPs have also done the same, in a context in which the guarantee of the Draghi government, while still appreciated by the markets, is no longer considered sufficient. The fault of the war in Ukraine unleashed by Vladimir Putin’s Russia, which changed, just when the whole world was recovering from the shock of the Covid pandemic, the characteristics of the world economy.
It almost makes you shiver to see that the rates on ten-year BTPs are more than double compared to three months ago when, at the beginning of February, they fluctuated around 1.42%. Even more merciless and difficult to digest the comparison with the value they had fallen to at the time of the advent of the Draghi government, which had fueled such euphoria on the Italian paper that ten-year BTP yields slipped down to 0.45% in February 2021.
The panic selling that BTPs are investing can be explained by both the monstrous public debt of Italy that with the exposure that the economy of the country has towards Russia, a country that has now become pariah due to the sanctions inflicted by the international community, Europe and the USA first and foremost, against Moscow.
L’boomerang effect of sanctions it is destined to be discounted above all by Europe, particularly exposed to the Putin regime as it is totally dependent on Russian gas, and struggling with the surge in public debts in the wake of the fiscal stimuli that various governments have launched in recent years to arm their economies from the devastating economic effects of Covid lockdowns. Italy, considered for years the weak link in Europe, is back on the investors’ radar, as shown by the disposals on BTPs. It must be said that galloping inflation across the euro area has resulted in a general sale of European sovereign debt, with ten-year rates on German Bunds which jumped up to%anticipating imminent rate hikes by the ECB.
Italy, Scope: non-temporary impact of sanctions against Russia
A glimmer of light for Italy is so dependent on Putin’s Russia comes with a report from Scope Ratings: “Italy: lower growth, higher inflation than euro area peers, yet EU funds should avert stagflation”that is to say: “Italy, lower growth, higher inflation than other euro area countries. Despite this, EU funds should be able to prevent stagflation“.
So Alvise Lennkh, Executive Director and Giulia Branz, analyst of the sovereign debt division of Scope Ratings:
“The continuation of the war between Russia and Ukraine it will adversely affect all Russian oil and gas dependent countries. Economies characterized by manufacturing sectors exposed to foreign countries are also exposed to the bottlenecks that continue to affect supply chains, due to China’s ongoing zero Covid strategy. In Europe, Italy (BBB + / Stable) is among the most vulnerable countries, together with Germany (AAA / Stable) ”.
Scope’s two analysts continued:
“Italy’s dependence on Russia’s energy – which affected consumption in 2020 for 50% in the case of coal, 40% for gas and 17% for oil – and the increasingly severe sanctions (against Russia) by the EU – which also seem to include the embargo on oil by the end of the year and perhaps on gas in the medium term – cloud the outlook for growth and stable prices for the period 2022-2024“.
For experts, “regardless of the government’s (Draghi) efforts to replace Russian oil and gas in the short term, something that could only offset the immediate impact of an embargo, the absence of affordable substitutes and available of the necessary amount (of energy) it will result in higher inflation and in low growth (of GDP) over the next few years “.
Consequently, “we believe the impact of sanctions against Russia on Italy it will be anything but temporary“.
This is why the outlook of Scope Ratings on Italy’s GDP for 2022 it was revised downwards to the range + 2% -2.5% from the + 4% growth estimated before the war, while for 2023 the prospects are for an expansion between + 1.5% and + 2%.
“The result is that Italy will return to pre-pandemic growth level only in the fourth quarter of this year, 6-9 months later than previously expected “.
Among other things, Scope’s outlook assumes that there are no problems in supplying gas.
In the event that they should manifest themselves instead the worst consequences that have been illustrated by the Bank of Italythe Italian economy, the report continues, would contract by 0.5% -1% in 2022 and 2023, against an increase in inflation of around 8% in 2022.
In this scenario, “assuming annual growth of around 1% and inflation of around 3% in 2023-26, largely in line with IMF estimates, Italy would suffer from worst combination of low growth and high inflation among the economies of advanced countries, reflecting the vulnerability in the short term towards the jump in energy prices and the weak growth prospects in the medium term ”.
Stagflation would be the most likely scenario, were it not for significant EU funding. The EU – it is recalled – is preparing to shell out About 70 billion euros, or about 4% of the 2021 GDP, for Italyin the period between 2022 and 2024, based on the Next Generation EU, equivalent to a contribution to annual growth equal to + 0.5% of GDP.