Italy’s Treasury bill auction yesterday went better than expected, and the yield on the 10-year bond fell from 7.4% on Wednesday to 6.8% on Thursday and 6.5% today. The Italian Treasury sold €5 billion ($6.8 billion) one-year bills yesterday. The average yield on the bills was 6.09%, the highest since September 1997, and almost 3% higher than last month’s average of 3.57% – but 6.09% was actually lower than expectations ahead of the auction.
Bloomberg reported that the Italian Treasury received double the amount of bids (€10 billion) for the €5 billion in bills that it auctioned, which dampened some fears that Italy is facing a funding crisis. Also helpful was the announcement by Greece of a new Prime Minister, Lucas Papademos, who is widely seen as a solid replacement for outgoing PM George Papandreou.
It was also widely reported that the European Central Bank bought more Italian bonds ahead of the bill auction and afterward as well. This helped bring the bond rate down below 7%. But the ECB also cautioned that it doesn’t intend to be the buyer of last resort for Italian debt. It won’t be known until Monday just how much in Italian bonds the ECB purchased last week.
Meanwhile, Italy’s Senate is rushing to pass debt-reduction measures that clear the way for establishing a new government. The Senate is set to vote today on a package of measures including asset sales and an increase in the retirement age. The Chamber of Deputies may vote as early as tomorrow, and Prime Minister Berlusconi will resign “immediately,” sources said.
With yesterday’s better than expected bill auction, and with the bond yield below 7%, it remains to be seen if things settle down in Italy following several gut-wrenching days as yields soared to new euro area highs. Frankly, it will surprise me if Italy’s financial firestorm is over, but there are a few things to keep in mind.
First, Italy’s debt-to-GDP ratio of 120% is troubling, no doubt, but Italy’s debt-to-GDP ratio has been over 100% since 1992. The country’s budget deficits have been coming down in recent years, and a modest budget surplus is expected in 2012. If the government can continue to run surpluses (and that’s a big IF) and succeeds in implementing the latest round of austerity measures, some analysts believe Italy can continue to roll over its $2 trillion in debt – assuming yields remain well below 7% and the economy does not fall into a recession.
On the other hand, if bond yields move back above 7% or to 8% and investors head for the exits in droves just ahead, it is hard not to envision more financial chaos and further weakening of Italy’s economy. The next few weeks will be critical as Italy has more large debt auctions around the week of Thanksgiving. Look for Italy to remain the 800-pound gorilla in the room.
Equity markets around the world are booming as this is written, so the roller coaster stock markets continue. As of noon (central time), the S&P 500 has almost recovered all of the losses from earlier in the week. But keep your seatbelts fastened tightly!
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