Italy

Following today's release of European manufacturing PMI data we are sadly no closer to getting any resolution on which way the great US-European divergence will compress. Because all we learned is that, very much as expected, Europe managed to contract for a fifth month in a row, with the average PMI in Q4 2011 the weakest since Q2 2009, essentially guaranteeing a sharp recession once the manufacturing slow down spills over to GDP. The only silver lining was that the contraction across the continent was modesty better than expected, however if this merely means that the band aid is being pull off slowly and painfully instead of tearing it off is up for question.

While we’re not bubbling over with optimism, we believe the New Year will be anything but boring. 

Today's most anticipated economic headline - the sale of 3 and 10 Year Italian bond - auction has crossed, and judging by the selloff in the Italian secondary bond market (north of 7% now) and the drop in the EURUSD, now under 1.2900, it was a solid disappointment. Italy sold well below the targeted EUR 8.5 billion in 2014, 2018, 2021 and 2022 notes, with the key 10 Year 5% bonds pricing in line with the target EUR 2.5 billion, and optically successful at 6.98%, just inside the 7% critical level. The Bid To Cover was a weak 1.36, barely an improvement from the 1.34 from November 29, the day before the coordinated Fed bailout of Europe, when the same auction cost Italy 7.56%. And this was the good news: virtually all the other discrete auctions were far uglier than the headline indicated with demand weaker across the board.

Despite European banks hoarding cash at the ECB at record levels as observed previously, Italy succeeded in selling ultra short maturity debt earlier today at interest rates that confirm Europe has managed to stabilize near-term expectations. Specifically, as Reuters reports, Italy sold 1.7 billion euros of 24-month zero-coupon bonds on Wednesday at an average 4.85 percent rate, sharply down from an auction yield of 7.8 percent a month ago.  The Bid to Cover was 2.24 compared to 1.59 previously. Nonetheless, this amount was less than the maximum 2.5 billion euros targeted at the auction. Italy also sold 9 billion euros of six-month bills at an average yield of 3.25 percent on Wednesday, half of what it paid a month ago to sell six-month paper at a bid to cover of 1.69 compared to 1.47 previously. Lastly, the fact that Italy can place debt in under 2 years when the LTRO itself has a 3 year maturity means that the real issuance test will come tomorrow when Italy is on deck to sell 3 Year bonds. As for 10 year BTP, which were trading at over 7% as recently as overnight, that is a different story completely.

It was just a little footnote to the LTRO announcement. Just a little statement that 40 billion of the collateral received by the ECB was newly issued, newly guaranteed Italian debt.  The more I think about it, the more uncomfortable I get. The ECB claims they have 40 billion of Italian government bonds on their books from the LTRO. The banks say they pledged 40 billion of Italian government debt. The Italian government doesn't acknowledge it as debt. Is this just a ploy to inextricably link the Italian banks to the government. The banks could have borrowed direct from the ECB. Bizarrely enough they may have even been able to post their own non government guaranteed debt directly but that was too obviously Enronesque? We are scared that as these contingent liabilities hit the spotlight we will find that the sovereign debt problem is far far bigger than we have realized. 

The EU was already embarrassed into releasing a press release that it could procure €150 billion in Eurozone contributions to the IMF rescue, now that the UK is out of the picture and the December 9 Eurosummit agreed upon total of €200 billion including non-Eurozone contributors (mostly the UK with €30.9 billion) has been "adjusted." Now we find that the rabbit hole goes even deeper into Bazooko's Circus because according to a just released update, of the remaining meager €150 billion in funding, Germany will be responsible for €41.5 bn, France at €31.4 billion, and Italy will need to provide €23.5 billion. To, you know, bailout Italy. #Ref!

Indicating just what a banana continent Europe has become, we present the latest, December version of the EFSF term sheet, where we want to emphasize just two things. First, as the slide below shows, even with Italian and Spanish bond yields blowing out beyond stratospheric levels, and is now glaringly obvious that Spain and Italy will be first in line for the next bailout which may come as soon as a week from today (thank you Australia), the EFSF still claims that Italy and France will be responsible to fund capital into the EFSF. How much capital? €232 billion to be specific. Which just so happens, is just under one third of the total amount that has been "guaranteed" by EFSF commitments (with insolvent Greece, Ireland and Portugal obviously stepped out). Let us repeat: One Third of the European bailout firepower resides with the insolvent Italy and Spain. We also get the following: "In case a country steps out, contribution keys would be readjusted among remaining guarantors and the guarantee committee amount would decrease accordingly." In other words, as we said back on July 21, when France is the last country to be stopped out of the contribution quota, it will be all up to Germany, or else. And second, and very near and dear to the recently popular topic of rehypothecation, we find that "Once purchased, EFSF could use for repos with commercial banks to support EFSF?s liquidity management." In other words, the bonds received to bailout the broke countries, can then be recycled with the ECB all over again (and potentially infinitely with no haircuts assuming Europe funnels everything through some London-based HoldCo), doubling down the capital burden on the ECB's already meaningless 5 billion capital tranche, then potentially re-repoed, and so on. And there are those who complain that Europe "does not print."

Presented with little comment, except to say reality is returning as credit markets are starting to price in some disappointment. Italy 5Y is underperforming as the basis trades we mentioned yesterday are unwound and Italy 10Y has broken back over 6% as their curve remains inverted. Spanish 10Y spreads are up over 35bps today and 50bps from yesterday's tight print as Belgium and Italy follow suit. The swing in Spanish 10Y spreads, on a percentage basis, is massive, empirically, from a 4.5 standard deviation compression on Monday to a 2.5 standard deviation decompression today as today's widening in the biggest relative jump since July 11th - more small doors and large crowds?

Confirming just how much the market has lost it, at just after 5 am Eastern when the news of today's Italian auction as announced, the EURUSD soared by almost 100 pips on news that the auction had not failed. Apparently the lack of day to day bond issuance failure is now good enough for Europe. In the meantime, one look at the actual auctions that made up today's action show just how unsustainable Italian debt yields have become. The Italian Treasury priced 3, 9 and 11 year BTPs at yields that were simply laughable, and are completely non-sustainable in the long run. Specifically, the Tesoro sold €3.5bln in 6.00% Nov'14 bonds at a bid/cover 1.502. The yield was a mindboggling almost 8% or 7.89% compared to 4.93% on October 28 - a 3% increase in 1 month; it also sold €1.499 bln of 4.00% Sep'20 bonds at a 1.538 B/C vs. Prev. 1.49 and a yield of 7.28% vs. Prev. 5.470% a month earlier, and lastly €2.5 billion in 5.00% Mar'22 bonds, at a bid/cover 1.335 vs. Prev. 1.27 and a yield 7.56% vs. 6.060% previously. Yup, the 3 years were nearly 8%! Yet as noted earlier the fact that anything priced was enough for a quick kneejerk reaction higher in prices on the benchmark 10 Year BTP... If only for one hour. As the chart below shows, the BTP has sold off aggressively post the realization that the "successful" auction was almost as bad if not worse than a failure, as that at least would have kicked the ECB into monetizing.

In the face of ponzi-enabling status quo adversity, Sean Egan is not one to mince his words. Sure enough, here comes today's downgrade of Italy from BB+ to BB, an event which has reminded BTPs, if not stocks for now, just what reality is. From the report: "La Acido Vita - from La Dolce Vita, life in Italy has become sour of late; even without the concerns about Greece, Italy is in miserable shape. Over the past 3 fiscal years, total debt has grown by 14.3% while GDP has shrunk by 2.4%. The annual government deficit of EUR68B and the debt to GDP of 119% place additional pressure on credit quality. Furthermore, Italy will probably have to  provide additional support to its banks and will see some pressure on its economy. We expect that Italy's banks will continue turning to the ECB and Italy for support. In 2012, the Republic of Italy needs to finance EUR320B of debt and is likely to experience increasing yields and restricted access without external  intervention. As of this weekend the yields on the 6 month notes were 6.5%; rates have been rising despite ECB purchases. The major issue is whether the IMF will become involved and if so, whether the face value of the debt will be cut. Italy cannot support all of its debt." And what is probably worse is that according to what are likely very optimistic projections, EJ sees Italian debt/GDP rising from 127% in 2011 to 157% in two years. Indicatively, the cutoff ratio for a CCC-rated sovereign credit in Egan Jones' view is 150% debt/GDP. Say hello to the triple hooks.

The La Stampa rumor that the IMF would bail out Italy has come and gone, roundly refuted by none other than the IMF as expected, but not before lifting futures by over 30 points in the premarket session, and setting a very favorable tone to the market overnight. How long it lasts now depends on the amount of time it takes the bipolar market to realize that the tapped out consumer, already at near multi-year lows in savings, will be unable to carry this holiday period despite what the Retail Federation reported about supposedly record Black Friday sales. But for now all is forgiven and not a moment too soon: after all S&P had just downgraded Belgium which was coming to market with a new 10 year bond issuance. And courtesy of the US consumer, the auction was not a failure, yet still pricing over 1% higher compared to a month ago, or at 5.659% compared to 4.372% on October 31. Still, the bid to cover rose, and thus the modestly successful auction saw the 10 year yield drop 16bps to 5.7%, the biggest decline in a month and the first in 6 days; hit 5.91% earlier, highest since  2000. Just shortly before Belgium, Italy sold €567MM in 2.6% 2023 Inflation Linked linkers at a bid to cover of 2.16 but most importantly at a yield of 7.3%. This was an epic collapse compared to the last such issuance from October 27 when 2.1% I/Ls due 2021 priced at a 2.14 B/C and a 4.61% yield: nearly a 2.7% increase. And somehow this unsustainable yield (not to mention another BTP auction tomorrow) is considered a good thing: the 10 Year dropped to just over 7% in the auction aftermath after hitting 7.3% earlier. And for now Europe is on the backburner with all eyes on how few contracts of ES can get the S&P up 3% today: all signs of a perfectly functioning market.

Something big has to happen soon, or else...

The European desperation is palpable ahead of the EURUSD open in a few hours, which has to deal with the aftermath of the Friday afternoon downgrade of Belgium, the junking of Portugal and Hungary, and the prospect of an imminent downgrade of AAA-stalwarts Austria and France. So what does Europe do instead of actually proposing the inevitable debt repudiation that is the only and final outcome? Why more rumors of course. To wit: last night saw the preannouncement of Welt am Sonntag indicating that in order to bypass the lengthy process of treaty changes, Europe would instead proceed with bilateral agreements that would somehow enforce fiscal stability and convince the market that European states would follow the German leader. Well since that is sure to have absolutely no impact, overnight Italian La Stampa is out with a fresh new rumor which cites "IMF sources" according to which the US-headquartered and funded organization would provide a €600 billion loan to Italy at 4-5%. In other words, Uncle Sam, in his role as primary funding agent of the IMF would lose massive amount of money on the "market to fair value" arbitrage, only to bail out the latest European domino. As a reminder, the whole "under market rates" loan from the IMF was implemented in Greece and worked out just swell: at last check the 1 Year Greek bond was trading with a yield of over 300%. Oh, and La Stampa forgot to mention one thing: any changes to the IMF, which currently is massively underfunded and is why the organization was forced to create two new liquidity facilities: a Precautionary and Liquidity Credit line, since it is unable to fund its New Arrangements to Borrow, have to go through US Congress when it comes to expanding funding capacity. Yup, the most dysfunctional, corrupt and criminal thing in the world - the US House of Representatives, where unless everyone is short Italian CDS, this will never pass. In other words: this rumor is dead in the water.

It was nice knowing you "sovereign" Italy. Next time get a "technocrat" PM/FinMin who is not a certified card carrying agent for a major banking cartel.

• MONTI SAYS EUROPE'S INDICATIONS ARE IN ITALY'S BEST INTERSETS
  
• MONTI SAYS EU CAN HELP ITALY DEVELOP BETTER POLICIES
  
• MONTI SAYS EU IS NOT A `CONSTRAINT' FOR ITALY
  
• MONTI SAYS ITALY'S PROGRAM PRESENTED TO EU IS `STARTING POINT'

Oh, and good luck finding that gold, a topic which finally makes the mainstream FT several weeks after Zero Hedge tentatively suggested that it's gone... It's all gone.

Time to start stocking up on those long term, OTM armageddon puts yet?