There is a very simple reason why in recent months Italian banks have been “forced” to buy near record amount of Italian debt (which for now at least is backtopped by the ECB): because nobody else wants them.
As frequent readers will recall, back in July we reported that during the first Italian bond crisis this year in May, when BTP yields soared after the populist government came to power, Italian banks purchased over €28.4BN in Italian government bonds, the largest monthly amount ever and higher than at any time seen during the 2012 sovereign debt crisis.
Two months later we showed the flip side: while domestic banks – still backstopped by the ECB – were scrambling to buy up all the BTPs they could find, foreigners were dumping it with bond hands. As the chart below shows, holdings of Italian debt by foreign investors declined by a net €38bn in June, eclipsing the previous month’s net fall of €34bn, which was itself a record.
So while we have known for a while that Italian banks were buying up all the Italian bonds that foreigners had to sell, an outstanding question is how did Italian retail investors feel about buying (or holding) the country’s debt?
We finally got an answer earlier today, when Italy held its first offering of inflation-linked bonds targeted at the retail segment since the market turmoil in May. The answer: a disaster.
As Bloomberg notes, “Italy’s domestic investors have given a resounding thumbs-down to the populist government’s funding efforts”, because retail demand for the bond offering saw the lowest number of orders for a BTP Italia issue since they were introduced in 2012.
Retail investors’ orders for the BTP Italia bond totaled €864 million at the end of the third day of the sale: a record low. That compares with the previous low of €974 million in 2012, and an all time high of €17 billion in 2013.
After raising €480m on Monday, investors signed up for €241m of bonds on Tuesday. The Wednesday balance was even smaller.
BTP Italia were first sold in 2012, shortly after Italy’s sovereign debt emerged from a near-death experience, and have since become a fixture on the Italian Treasury’s issuance schedule every six months. Each sale takes four days; books open first for individual investors, and institutional investors are then able to join in on the final day.
While normally the sale of the bonds – which pay a coupon of 1.45% for four-year debt – would be deemed a failure, the Italian Treasury may still raise an estimated €5 billion ($5.7 billion), with the bulk of it coming on Thursday, the last day of the fund-raising exercise, which is open only to institutional investors. Alas, as of 9am London time, the prospects were looking bleak with institutional order books only at 660 million euros, well below the previous low of 762 million euros that professional investors bought in 2012, and very, very short of the 10.5 billion-euro high in 2014.
Davide Iacovoni, director-general of Italy’s debt management office, blamed the volatility in Italian bond yields for the low level of demand for the new BTP Italia.
“Higher volatility weighed on the BTP Italia offer like it weighed on other government bonds and the sale is below expectations,” Mr Iacovoni told Reuters in a phone interview. “Market volatility has encouraged caution especially among wealthier investors who rely on private bankers and asset managers.”
In the past 6 months, Italian 10-year yields have soared 150 bps this year to 3.50%, while the closely watched spread over German bunds has more than doubled to 315 bps. The Italian government recently hinted that a spread of 400 bps could result in deposit runs and bank failure. Yet while the higher bond yields should have made them more attractive to retail investors, the recent price fluctuations most likely put many investors off the sale, according to NatWest Markets Plc.
“The spread is in the Italian press daily, so there is a good deal of awareness of recent volatility among Italian savers,” said Giles Gale, an interest rates strategist. “Their support is important symbolically.”
The vote of no-confidence by local retail investors – who unlike Italian banks don’t have the benefit of an ECB backstop – will be a major worry for Italy’s leaders as they look to borrow more money to finance their policy proposals, which as is widely known are the basis for an unprecedented standoff between Rome and Brussels. The government of Italy, whose $2 trillion in debt makes it the 2nd most indebted European nation, has penciled in a jump in the budget deficit to 2.4% of GDP, putting it in conflict with the European Union’s spending rules, and resulting in the historic launch of an Excessive Deficit Procedure by the European Commission, meant to punish Italy for its high-spending ways.
It only gets harder from here.
On Wednesday, the EU took the first step toward imposing fines on the region’s fourth-largest economy after stating the coalition administration’s spending plans violate the bloc’s rules, and calling for the launch of the infamous Excessive Deficit Procedure (whose bizarre, bureaucratic event flow is listed below).
Despite the trigger of the EDP, on Thursday Italy’s Deputy Prime Minister Matteo Salvini said that he won’t back down on the budget in an interview with RAI television. He added that he was “concerned” about the nation’s bond yield spread with German securities, but added that it cannot be controlled by the government. And while his stance may not be popular with investors, support for his party has grown in recent months, according to polls, putting Brussels in the tough position of risking to alienate the Italian population further should it push the populist government too hard; at risk could be the future of the Eurozone because should Italy decide to quit the common currency, the European experiment is over.
For now, the tense standoff between Rome and Brussels is mostly in its jawboning stage, however as the next chart below shows, the time for action is coming soon, and while neither side wants to take definitive action and would much rather resort to harsh language and posturing, that will not be possible for much longer.
“The Italian Treasury has seen little more than lukewarm retail demand for its inflation-linked BTP Italia issue,” said Marc Ostwald, global strategist at ADM Investors Services. It serves “as a reminder that while the public may be applauding the government facing down the EU, investors are clearly voting with their pockets.”
And with retail investors boycotting their country’s sovereign debt, there are just 40 days until the biggest risk facing Rome becomes reality: on January 1, 2019 the biggest – and realistically only buyer – of Italian debt, the ECB…
… will stop purchasing and backstopping its debt. And should foreign and domestic retail investors still refuse to buy the bonds, with banks now out of the picture (as their purchases will no longer be implicitly guaranteed by Mario Draghi), it is anyone’s guess who the current Italian government will fund itself. The lack of a definitive question is why two weeks ago, Fitch warned that Italy’s populist government may not survive. However, with popular support for the League and 5-Star near 60%, the likelihood of a smooth political transition to a technocratic, or even more centrist, government, is virtually nil.
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