Heading into the second half of May, just as the political turbulence in Italy was rising as investors took fright at 5-Star’s attempts to form a coalition government with the anti-immigrant League party, and what was initially a trickle of selling in Italian BTPs became a full-blown liquidation panic, some Italians wondered if the Mario Draghi wasn’t using a page from the Sylvio Berlusconi playbook, by allowing Italian bonds to tumble without ECB intervention, simply to “pressure” the domestic political process against the formation of a populist, Euroskeptic cabinet, something European Budget Commissioner, Guenther Oettinger scandalously suggested last week when he said that “the negative development of the markets will lead Italians not to vote much longer for the populists.”
Indeed, as we noted last week, several politicians suggested at the end of May that the ECB was exacerbating the sharp market moves: “It would be useful to know how much debt the Bank of Italy and the ECB have bought compared to the norm? Have purchases gone down?” tweeted Carla Ruocco, a Five Star MP, at the peak of the market turmoil last week.
Impennata dello #Spread: sarebbe interessante conoscere quanti #BTP #BCE e #Bankitalia hanno acquistato questa settimana rispetto al solito. Non saranno mica scesi? Qualcuno ci leva il dubbio?! pic.twitter.com/YgBmPOaOtW
— Carla Ruocco (@carlaruocco1) May 29, 2018
Elsewhere, Laura Castelli, another Five Star parliamentarian close to leader Luigi Di Maio said in an interview with Huffington Post that “the ECB and Italian banks have slowed up if not suspended their buying of BTP [Italian government bonds] . . . which is adding to pressure on spreads”. She also argued that “quantitative easing is being weakened at exactly the moment when we need it strengthened to secure the stability of the EU.”
As it turns out, skeptical Italians was proven right because as the ECB revealed when it disclosed its PSPP bond purchases for the month of May when “lo spread” between the yield on Italian and German government bonds blew out to its highest level for five years – leading some of the country’s politicians to hit out at perceived “bullying” from the bond markets – the central bank sharply scaled back the proportion of Italian purchases relative to all other bonds purchased under QE in the month of May, which according to the FT is an “admission that could fuel suspicions of the new Eurosceptic Italian government that the central bank is seeking to punish it.”
As shown below, in total less than 15% of ECB’s net May purchases were of Italian debt, the lowest proportional allocation to Italy since the bond-buying program began in March 2015.
And with relative Italian purchases tumbling, some other nations must have seen its bond purchases jump. Sure enough, that someone was Germany, which as the chart below shows, saw its net purchases of bond as a % of total, soar to the highest since the program began.
Of course, any hint the ECB is intervening in markets to push for a specific political outcome, even though it did precisely that in November 2011 when a crash in Italian bonds led to the ouster of then-PM Sylvio Berlusconi, would lead to a huge European scandal in which the “apolitical” central bank is seen as intervening in domestic politics, and the bank came out prepared with a statement “explaining” precisely why Italian purchases tumbled, and to deny Castelli’s allegations that the ECB’s QE was being weakened “at exactly the moment when we need it strengthened to secure the stability of the EU” just to punish Italian voters who picked a populist government.
This is what the ECB said:
“Several countries including France, Austria and Belgium saw their share in net purchases go down in May, not just Italy. This is the result of agreed and communicated rules on the timing of re-investments.”
Yes, but no other nation saw its share drop as much as Italy; a plunge which certainly exacerbated the low liquidity liquidation that sent “lo spread” above 300bps.
Furthermore as the ECB’s spokesman tried to explain, there was a high volume of German bond redemptions in April which could not all be reinvested in the market during that period, so “some of these re-investments were spread also to May to ensure a smooth implementation.”
Confused? The ECB just blamed the plunge in relative Italian bond purchases, and the surge in German, on a calendar quirk. The ECB continued: “In absolute terms, the amount of net purchases for Italy in May (EUR 3.6 bln) was higher than, for example, in March (EUR 3.4 bn) and January (EUR 3.4 bn). Gross purchases for Italy were actually higher in May than in April (around 32% higher).”
Indeed, but again on a relative basis they plunged, and that’s all that traders in Europe – where nations pretend to be at least relatively equal – cared about.
Incidentally, as we reported last week, the ECB said that it was watching political events in Italy but was unlikely to intervene by buying debt. Well, it clearly did intervene by purchasing debt… of Germany, much to Bill Gross’ chagrin, as the relative outperformance of Bunds over US Treasurys led to the biggest one day loss for Bill Gross’ unconstrained fund.
Finally, in light of the ECB’s sudden drop off in Italian bond purchases in May, it is hardly surprising that as we reported on May 31, the Italian Ministry of Finance announced it had unexpectedly repurchased €500 million in 2 Year BTPs…
… surprising market watchers.
And while the Italian bond crash has been put on hold for now, the far bigger question remains: what happens to this artificially supported bond market, in which politicians scream bloody murder when the ECB tapers its purchases even modestly, when the ECB fully ends its QE and stops monetizing public debt as it is widely expected to do on January 1, 2019?
* * *
Following the news that the ECB had purchased fewer Italian bonds in May, the FTSE MIB slumped to session lows, with Italian banks following suit as Italians are given a stark reminder just how precarious the price of every single asset in the country is without the continued support of the ECB.
Needless to say, Italian politicians were not happy: Claudio Borghi, the League’s top economic adviser, said it was “no surprise” to discover the ECB had been buying more German bonds. “Since Draghi promised to do ‘whatever it takes’ the biggest players in the Italian bonds market has been the ECB and they fix the price,” he told the FT.
“It is necessary to clarify the storytelling about Italian debt. It is not general markets’ that have the greatest influence on the price but the ECB is by far the biggest factor.”
Borghi, is of course, correct, but the next question is: so what? Yes, Italian bonds are massively mispriced and they will plunge if and when the ECB stops supporting the market, in effect holding Italy hostage. As for the biggest question, it is what, if anything, Rome has up its sleeve to avoid such a fate when Draghi’s QE finally ends.
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