This page has been archived and commenting is disabled.

Goldman On Italy - Part 3

Tyler Durden's picture




 

This morning brings the latest, or the third, in the ongoing pitch book of Italian bonds by Goldman's Francesco Garzarelli, in which the strategist hopes that third time will be the charm for calling the bottom to the BTP collapse (sold to you, Goldman client). What apparently has Goldman confused is how its former employee Mario Draghi has let BTP spreads hit the record and unsustainable levels they did yesterday. To wit: "We were actually quite surprised not to see more forceful intervention by the central bank in secondary markets after the LCH announced it would raise initial margin requirements (and wrong in assuming it would have helped keep the Italy vs. AAA spread close to 450bp – it closed yesterday at 500bp over, but is now back at 450bp)." Here Goldman confirms what we suggested on Monday: that the ECB is now nothing but a policy enactment and dictator overhaul tool: "In this context, Italy still has to comply fully with the ECB’s ‘requests’ dated August 8, while Greece’s commitment to more austerity in exchange for financial support has continued to sway (at the time of writing, news that former ECB no. 2 Papademos would take the helm is encouraging)." Even so, the future to Goldman is quite cloudly :Granted, one positive collateral effect of market tensions has been to precipitate a political shakeup in Italy. But the collateral damage created by the price shock in Italian bonds to the stability of the EMU project (aggravated by explicit talk of countries being expelled from the single currency) is high and quite lasting. It will probably take a leap forward into deeper forms of fiscal risk-sharing (Prof Monti is a long-time proponent of Eurobonds) to get the market properly functioning again." OTOH, Barclays has done the math, and as we pointed out a few days ago, is not surprised.

Full note from Goldman Sachs

An Update on Italy - Collateral Effects

An intensification of pressures on the Italian government bond market, especially after the introduction of higher initial margin requirements on repo by LCH yesterday, appears to have unlocked a stalemate in Italian politics. New fiscal measures (technically, an amendment to the Stability Law), which were scheduled to be voted on in Parliament by the end of next week, will now be discussed expeditiously and most likely rubberstamped by this Saturday. This should then prompt the resignation of PM Berlusconi, who has publicly pledged to step aside after their approval. According to the media, there is now a greater chance that a ‘technocrat’ government including high-calibre personalities such as Prof. Mario Monti and former PM Giuliano Amato may be sworn in by the start of next week. It would seem that Mr. Berlusconi himself has endorsed this solution, as the new Cabinet will likely include members of the PdL party. If confirmed in the coming days, this would represent the most market-friendly outcome at this juncture.

To be sure, the road remains uphill for Italy. The new Italian government will have to pass important and politically controversial economic reforms in the coming months under close scrutiny by the ‘troika’ and markets. Debt roll-over needs also run high (around EUR25bn in December and around EUR114bn in 1Q2012), and some help from either the EFSF or IMF backstop credit lines may be needed along the way. But a strong and reputable government leadership should reduce policy implementation risks (thanks to what we have previously called an ‘initial contracting’ with political parties on the policy programme), allow greater discretion on the sequencing of the individual measures (in recent pronouncements, Monti has emphasised growth-enhancing measures, while Amato has declared himself in favour of a wealth tax) and hopefully mitigate social tensions.

In terms of the bond market, we would expect a reduction of spreads following the appointment of a technocrat government, and a more gradual (and volatile) decline in yields after the successful introduction of new measures over the coming months. As we stated in a recent Global Market Views, we continue to see 350bp over 10-yr Bunds as a credible level around which spreads could settle (currently 530bp). But it will likely linger until a more decisive pan-Eurozone response is finally available (the much-heralded Euro area ‘firewall’ to fend off contagion from Greece is still under construction). In this context, whether the ECB is willing to engage in more pro-active purchases remains to be seen.

We were actually quite surprised not to see more forceful intervention by the central bank in secondary markets after the LCH announced it would raise initial margin requirements (and wrong in assuming it would have helped keep the Italy vs. AAA spread close to 450bp – it closed yesterday at 500bp over, but is now back at 450bp). To be sure, this fits with Mr. Draghi’s pronouncements at his first press conference: the ECB is picking up the slack, not fixing prices. A broader policy of ‘zero tolerance’ towards states reluctant to undertake fiscal action is also taking hold. In this context, Italy still has to comply fully with the ECB’s ‘requests’ dated August 8, while Greece’s commitment to more austerity in exchange for financial support has continued to sway (at the time of writing, news that former ECB no. 2 Papademos would take the helm is encouraging). Granted, one positive collateral effect of market tensions has been to precipitate a political shakeup in Italy. But the collateral damage created by the price shock in Italian bonds to the stability of the EMU project (aggravated by explicit talk of countries being expelled from the single currency) is high and quite lasting. It will probably take a leap forward into deeper forms of fiscal risk-sharing (Prof Monti is a long-time proponent of Eurobonds) to get the market properly functioning again.

Two observations also deserve to be considered:

Italy undoubtedly has large responsibilities for not being ‘ahead of the curve’ in its fiscal strategy, especially after the central bank stepped into the fray in early August. But the sharp widening in Italian BTPs started in mid-June, after the introduction of ‘substantial’ private sector ‘burden sharing’ (PSI) in the restructuring of Greek debt (which had previously been ruled out by policymakers). The ECB itself had cautioned that PSI would lead to contagion in a deeply integrated financial area, and was proven right. Aggravating problems, policymakers have been unwilling to allow sovereign CDS to be triggered, perhaps out of concern of unintended effects. But, on learning that a severe bond restructuring would not be considered a credit event, many investors apparently judged that they had less risk protection than they thought, and reduced bond exposures.

The recent decision by the European Banking Authority (EBA) to oblige EU commercial banks to strengthen capital positions by building up a ‘temporary’ capital buffer against sovereign debt exposures, including those of Italy, has set in motion a perverse chain of events. Banks sold sovereign securities, preferring to park money with the ECB, and have reluctantly participated in the primary market. The resulting decline in prices following these bond sales perversely led to more sales, and a progressive destruction of demand. As a result, 5-yr BTPs, for example, are now 10 points below where they were at end-September, when price marks were recorded for the recapitalization exercise, illustrating the adverse loopback effects that policy decisions have introduced.

As we argued in previous writing, given the inadequate fiscal governance of the Euro area, the ECB has been saddled with quasi-fiscal responsibilities in this crisis and, understandably, is trading off moral hazard risk (i.e., will the Italian government continue to ‘free ride’ bond purchases, and aggravate economic and political tensions among member states) with financial instability. But the price action since June has been amplified by unexpected changes in regulations and private contracts introduced by governments, creating much uncertainty and thus a self-reinforcing price action. Should a more decisive fiscal response be delivered in Italy, as we expect, and markets not take notice, then a more pro-active approach would be warranted. As Dom Wilson writes in this morning’s Global Markets Daily, ‘doing an SNB’ (unlimited purchases at a set price) may be an effective and ultimately cheap way to halt a dangerous slide.

 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Thu, 11/10/2011 - 08:58 | 1865327 Paper CRUSHer
Paper CRUSHer's picture

Okay people,as we all well know  the Central Banks daily interventions and bailouts increase in size so its kinda fittin' to say 'that bigga is betta', so what d'ya know ol'Perth Mint decided to unveil this monster......

I'll tell ya its one big mutha!

http://www.1tonnegoldcoin.com/

Thu, 11/10/2011 - 09:17 | 1865378 jdelano
jdelano's picture

Stopping to think about this, I realize the only way that the CB cartel could possibly bring Berlusconi in line is by threatening his family--that should be interesting.  There are going to be inexplicable, "accidental" deaths of high profile figures very soon.  

Thu, 11/10/2011 - 09:37 | 1865475 s2man
s2man's picture

I'm sure they are hedged for that.  No, wait.  Zero Hedge...

Thu, 11/10/2011 - 09:35 | 1865467 ArkansasAngie
ArkansasAngie's picture

And ... the fact that the shatheads who got us in trouble are taking over is interpreted as good shows you how rigged this is.

They are going all in.

Thu, 11/10/2011 - 08:59 | 1865333 qussl3
qussl3's picture

"Unlimited purchases at a set price"

Fuckers should be shot.

Thu, 11/10/2011 - 09:28 | 1865425 Mike2756
Mike2756's picture

At a 50% markdown?

Thu, 11/10/2011 - 09:02 | 1865342 lolmao500
lolmao500's picture

So when do people get out of the euro after the obvious Italian bond fixing by the ECB? Never? That's what I thought.

Thu, 11/10/2011 - 09:05 | 1865346 aleph0
aleph0's picture

Just wondering ...

... whether there are enough ex-GS'ers to go around,
like 17 ?
;-)

European elections 2014: Europe's politicians are being strategically replaced

http://translate.google.com/translate?sl=de&tl=en&js=n&prev=_t&hl=en&ie=...

Thu, 11/10/2011 - 09:06 | 1865350 Trad3er_1337
Trad3er_1337's picture

whats the bet that the ECB told italy  "were going to step away just for one day and not support your bonds" just to teach them a lesson, using a little shock therapy...

Thu, 11/10/2011 - 09:10 | 1865355 Racer
Racer's picture

Isn't the ChairSATAN the biggest unelected dictator ever?

Thu, 11/10/2011 - 09:18 | 1865370 MassDecep
MassDecep's picture

Bottom Line

"the ECB will be forced to directly monetize debts across the entire eurozone." "The U.S. has unfunded liabilities many times the size of Italy's unfunded liabilities. Including unfunded liabilities, while Italy's total debts are approximately 300% of their GDP, the U.S. has total debts equaling about 600% of its GDP."

Just wait til our bond yields jump

 
Thu, 11/10/2011 - 09:33 | 1865453 s2man
s2man's picture

I expect a continued flight to the perceived safety of the USD/TSY as Europe falters.  But it won't continue for very long.

When our yields jump, and further debt is unavailable, then comes the monetization of the debt.  Pile on lower revenues due to spiraling higher unemployment and lower consumer spending in positive-feedback loop. Can you say 50-100% inflation?

Its gonna be a bitch.

Thu, 11/10/2011 - 09:41 | 1865474 SheepDog-One
SheepDog-One's picture

Oh I see, the problem with Europe is just the leaders there, and just a swap of leaders here and there fixes everything. And bankers are in charge of doing that. Uh, yeaaaaaaaa....

Thu, 11/10/2011 - 10:01 | 1865590 XXL66
XXL66's picture

Italy should try no government like we here in Belgium, works great !!!!

Thu, 11/10/2011 - 10:11 | 1865599 thepigman
thepigman's picture

Eurozone is done. Whatever the "new Europe" is has not yet been

revealed. ECB is a paper tiger and Germany will not let them

print their way out. This will overhang global markets indefinitely.

Gonna be a mess. ZH er's should rejoice. The black swan 25X

bigger than Lehman is now firmly entrenched.

Thu, 11/10/2011 - 10:38 | 1865788 MassDecep
MassDecep's picture

Germany has no choice but to let the ECB print money to prop up the EU. Otherwise, German Banks fall flat on their face. To heavely invested in EU debt....

Thu, 11/10/2011 - 11:03 | 1865913 thepigman
thepigman's picture

You're wrong. Just sayin....

Do NOT follow this link or you will be banned from the site!