Sometimes we regret that the day only has 24 hours. Whose idea was that? Perhaps we should blame Einstein (evil inventor of the spacetime, gravity and other ills afflicting mankind). So many things are happening these days and usually at such startling speed that it is not easy to keep abreast of it all.
When we posted our little update on the evolving situation in Italy yesterday, Italy's 10 year government bond yield had just hit a new high of 5.93%. However, it then retreated to end the day slightly lower. Similarly, a huge sell-off in European stock markets and the euro was at least partially reversed later in the day. Unicredito's shares were briefly halted after plunging another 7%, but then recovered into the close and ended the day up 5.9% (which cut year-to-date losses to roughly 40% and the loss over the past month to 22%).
As far as we can tell there were two major developments accounting for this.
First of all, an Italian auction of one year bills went 'better than expected' – of course, we know all about these 'better than expected' government debt auctions from the time when the governments of Portugal, Greece and Ireland still financed themselves regularly in the markets. Although their bond yields and CDS prices were in a clear uptrend and the fiscal situation of these countries kept deteriorating, the debt auctions magically always went 'better than expected'.
It is easy to deduce why: the commercial banks of these countries were the bidders that showed up so faithfully. They were backstopped by the ECB, to which these bonds were duly pawned off as collateral. It is probably no different in Italy – the banking cartel of the euro area is laden with Italian government bonds, so we can assume that there is great interest in keeping up pretenses.
We would also note that in our opinion, the rumor that was started yesterday about Italian banks failing the EBA (European Banking Authority) stress tests was probably false. We are assuming that Mario Draghi already knows the results that will be published on Friday and he clearly said that Italy's banks would pass.
As Reuters reported on the bill auction:
Italy's short-term cost of borrowing jumped by 150 basis points compared to last month at a bill sale on Tuesday, although markets breathed a sigh of relief that it was able to place the full amount.
The 6.75 billion euro sale was the first test of appetite for Italian paper since a surge in nerves that it will be next to fall in the euro zone's debt crisis due to domestic political tensions and a combination of high public debt and low growth.
The gross yield on the 12-month BOT bills rose to 3.67 percent from 2.147 percent at a previous auction in June. This was the highest level since September 2008, according to Reuters calculations on Italian Treasury data.
"Italy has sold the target amount, which should give the market some relief in the very short term," said Peter Chatwell, a rate strategist at Credit Agricole.
(emphasis added)
If recent history and experience is any guide, the relief will prove to be short-lived. Yes, there will be many more 'successful' debt auctions – until the costs become prohibitive. Italy must refinance € 500 billion in debt over the next three years – € 69 billion of which need to be rolled over in August and September this year alone. This serves as a good reminder that in modern times, government debt is never 'paid back'. It is simply 'rolled over' and keeps growing. And of course, although there is a clear difference between money and credit, our whole fiat money system is 'based' on debt which leads to interesting dynamics – in the Chinese curse sense – whenever the unpayability of said debt is suddenly 'discovered'. In the euro area, the institution of a supranational central bank has served to hasten this discovery process.
As an aside to the above, there were also rumors circulating that the ECB once again intervened in euro area bond markets. Whether this is true or not can not be determined with any certainty yet, as the ECB only discloses such interventions after a period of mournful silence (the ECB is not happy with these interventions, and who can blame it? They don't work!). There was an interesting article at the FT's Alphaville blog ('No, The ECB can't Prop Up Italy') in which it is argued that Italy is in fact a bridge too far even for the ECB (at least for now). We certainly agree that the 'ECB can't prop up Italy', since evidently it couldn't prop up Greece, Portugal and Ireland either. That doesn't mean it won't eventually try.
