Italy Or USA - Where Would You Put Your Money?
While at a glance this may seem like a straightforward question with a simple and obvious answer, troubled Italian bank UniCredit has released a ponderous article comparing and contrasting the two heavily indebted, politically challenged, and growth-retarded nations. Comparing debt-to-GDP ratios and trajectories, GDP growth, and unemployment (as well as funding needs), the answer actually becomes a little less obvious and boils down to the central bank (as does every trading decision in the world currently).
From UniCredit: Italy or the United States: Where would you put your money?
Obviously Italian interest rates are being driven by the systemic concerns in the Eurozone. What UCG considers - is the spread differential justified by fundamentals? As the super-committee grapples with the reality of the budget and Berlusconi's new boy faces austerity, IMF estimate for gross debt-to-GDP actually converge by 2016:
After discussing unemployment outlooks and growth, they find that indeed, the fundamentals (from an economic outlook) favor the US over Italy but their view is that the market's perception of the difference is misplaced.
Because at the end of the day investors are not concerned about GDP growth rates themselves, but about the implications of the economic performance for the health of the public finances. And while stronger growth rates undoubtedly help, they are no guarantee for lowering the debt. That is unequivocally shown by the latest IMF projections. While the fund expects the US to grow faster than Italy, it at the same time projects much higher deficits for the US. In five years time, the US is even likely to have a larger debt-to-GDP ratio, but right now the Italian government has to pay seven times as much for a 5-year bond than the US Treasury. How comes?
They summarize (and the full report is below) that the difference:
seemingly all boils down to the second explanation, which is of course the behavior of the central banks. While both the Federal Reserve and the ECB have been buying government bonds in recent months, it is obvious that the ECB has been much more reluctant to do so. In the (currently unlikely) event that the US Treasury will have problems to rollover maturing debt in the market at reasonable rates, it is probable that the Federal Reserve would step in again and buy even more government bonds. In combination with the direct demand effect, that implicit insurance puts downward pressure on Treasury yields, as investors are demanding only a very low risk premium. The situation in Europe is very different, and we simply do not know how many more government bonds the ECB is willing to buy. The reasoning behind the ECB’s more cautious attitude has repeatedly been articulated loud and clear: While additional bond purchases could help in the short-term, they might come at long-term costs, such as high inflation rates or a less stable EUR.
Leaving readers with an interesting question (and one we prefer not to have to answer, chooisng c) none of the above):
if you were a medium-term investor, where would you put your money: In a country that hopes things will miraculously improve on its own, or in a country that has realized that reforms are needed and that has shown the willingness to take the painful steps in the right direction?
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