Italy

When last week Italian bonds threatened to plunge every single day (to levels seen earlier today, when the spread between the 10 Year BTP and the Bund has soared to 490 bps), many speculated that the ECB intervened every single day, and occasionally two or even three times daily. Now we have confirmation that in his first week on the job, Mario Draghi is already well on route to undoing everything that his predecessor did previously: his first action as head of the ECB was a surprise lowering of rates, and now he has bought double the amount that the ECB purchased in the prior several weeks, and the most since September 16. Altogether the ECB has monetized, granted with sterilization for now until of course Europe's banks end up being unable to sterilize these purchases and the ECB ends up holding the full unsterilized bag, a whopping €188 billion since its inception in May 2010. Of this, €110 billion has been dedicated exclusively to Spain and Italy, or rather, just Italy. This is in three short months. Good luck to the ECB as its winds down its SMP program, as mandated by Germany, and the EFSF is supposed to commence buying Italian paper in the open market.

When all else fails, and with the Italian 10 Year hitting a new all time record of 6.6% and sending the Bund-Italian spread to the nausea-inducing 500 bps, all else has failed, spread wishful rumors of resignations. Sure enough, the Italian 10 year notes have pared dramatic losses amid reports of an imminent Berlusconi resignation. Italian PM Silvio Berlusconi may step down within “hours,” according to an article written by former minister Giuliano Ferrara in the online edition of Il Foglio, news agency Ansa reported. "Some people say it could be minutes,” Ferrara wrote on the website, according to Ansa. This, coupled with yet another round of ECB intervention has managed to bring the spread inside by... a meager 17 bps, keeping the Italy Bund spread still a well over 470 bps.

Three months ago, in exchange for the ECB's expansion of its sterilized monetizations of bonds to include Italian BTPs, allegedly the only backstop that has prevented Italian bonds from experiencing an all out collapse to date, Italy was presented with a list of strict "austerity" demands, among which were spending cuts, higher revenues and labor reform. Since then none of these has occurred... or will occur, simply because Berlusconi has no control over the government, yet neither does anyone else, although everyone in the local government enjoys having a scapegoat for the total chaos. It appears that the ECB has just made it clear that the status quo is about to end, unless Italy does in fact push with something. And unlike other cases, where politicians on both sides of the table are happy to spout rhetoric while knowing well that nothing will change, in this case, courtesy of Italy largely untenable debt profile in which €166 billion in debt and interest are due in 2012, the ECB will have no choice but to play hard ball. Reuters has just confirmed that, reporting that  The European Central Bank often discusses the possibility ending the purchase of Italian government bonds if it concludes Italy is not adopting promised reforms, ECB Governing Council Member Yves Mersch said. "If we observe that our interventions are undermined by a lack of efforts by national governments then we have to pose ourselves the problem of the incentive effect," Mersch said according to extracts of an interview with Italian daily La Stampa to be published on Sunday. In other words on Monday the market will have to not only digest the implications of what the implications of the Greek vote of confidence are (last we checked G-Pap is still PM, and likely will be for quite a while), but also what happens now that the ECB has issued an ultimatum to Berlusconi to get his house in order. The problem is that he can't. Not without stepping down, that is. At that point the Italian pseudo stability that everyone has been taking for granted knowing full well it is nothing but an illusion, will fall and expose all the rot underneath. At that point we will truly see just how "hedged" all those Primary Dealers are, who have perfectly offsetting short positions to all their longs.

As we have been claiming for months now, Italian banks will have no choice but to raise capital to prevent their undercapitalized status from stirring the insolvent bank vigilantes and making them into the next MF, or Lehman, or pick your favorite bankrupt bank metaphor. Today we get confirmation of this, after Reuters reported that Italy's UniCredit will proceed with a €4 to €7 billion capital raise. So far so good. Where it gets somewhat entertaining is the disclosure of who it is that will be "advising" UniCredit on its capital raise. Per Reuters, "Mediobanca and Bank of America-Merrill Lynch are advising Italy's UniCredit on a capital increase seen in a range of between 4 billion and 7 billion euros, although no formal mandate has been given yet to form a consortium for the operation, sources close to the matter said on Thursday. The sources said a decision on the size of the capital hike depended on a series of factors, including whether UniCredit would be allowed to calculate convertible notes worth some 3 billion euros as core capital." Did they just say Mediobanca and Bank of America advising another bank on... a capital raise? Uh, pardon our ignorance, but shouldn't Mediobanca and Bank of America be focusing on their own capitalization first before advising someone else? Does this mean that Bernie Madoff has somehow magically made his way to the Treasury Borrowing Advisory Committee and is now advising Tim Geithner on how to raise debt? Or that Jon Corzine is running for US Attorney General? Frankly, nothing would surprise us any more... Presenting the YTD performance of all three banks.

We have discussed this a few times over the last year and as Greece begins to show signs of defection, it is perhaps worth considering what a spoiled and chided sovereign might do in a temper tantrum. Peter Tchir, of TF Market Advisors, puts it best this morning: "Everything I have read over the past couple of weeks coming out of Italy, tells me that if there was one country prepared to "screw" the Euro and go it alone, it would be Italy.  They don't like Merkozy treating them like children, and they have a big enough economy that a dirt cheap Lire would make exports possible".

The duration of the European bailout was 48 hours give or take. And now reality is back in the form of the following headlines:

• Italian 10 Year BTP Yield surges to all time high 6.153% before ECB intervention takes it back to ... 6 122%
• Expressed in price, they have dropped to a record 90.697
• Italian-German 10 year yield passes 400 bps
• Italy CDS soar 22 bps to 427 bps
• Italy 5 Year yields bonds join drop, yield rises  to over record 5.91%

See a trend? The one thing Europe was trying to avoid, contagion spreading to Italy, has happened.

With the EFSF, Italian and Spanish debt all creeping higher in yield today and a disappointing Italian auction, we take a deeper dive into the mechianics of the EFSF and the paradoxically weak impact it may have as sovereign risk deteriorates. The [EFSF] idea works well when people aren’t thinking there is a real chance of default, but as that increases, the EU may wish they had stuck to their original plan of having raised 440 billion of cash that they could lend directly.  Basically, if the markets deteriorate, the first loss protection, is worth more, but provides less leverage.

Don't anyone say Italy is not willing to tackle austerity with the determination of a rabid dog: retirement age to be raised by 2 years in 15 years, and an epic €5 billion to be raised from privatizations.

Over the past few days, Italy has promptly re-emerged as a main cog in the illusion that Europe is a well-greased machine (yes, we know, funny) after it became clear that the country continues to refuse to implement any actual austerity measures following the requirement to do just that months ago when it got access to the ECB's sterlizied bond monetization scheme. In fact it got so bad that yesterday the entire Italian government was rumored to be on the verge of collapse as it was once again unable to reach a resolution on what the EU demands are prompt actions taken to raise pension and/or retirement age. According to the Telegraph, Italy may have found a compromise, one which actually ends the regime of Berlusconi... but not yet. Telegraph reports that Silvio Berlusconi has reportedly drawn up a "secret pact" under which he will resign in December or January, paving the way for Italy to elect a new government in March. "The embattled prime minister made the deal with his key coalition ally, Umberto Bossi of the devolutionist Northern League, in return for Mr Bossi's support for pension reforms, according to unconfirmed reports in two Italian newspapers – La Repubblica and La Stampa. Italy is under huge pressure from the European Union to reform its pensions system and extend retirement ages as part of a plan to rein in its enormous public debt and revive its moribund economy." "Don't make a fool of me in Brussels, and I promise that we'll go to elections in March," Mr Berlusconi told the Northern League leader, according to La Repubblica." This would all be great, if only for one small snag: the "plan", like everything else in Europe, is worthless. The FT reports that the compromise agreement "lacks specifics and risks falling short of what eurozone leaders have demanded ahead of Wednesday’s summit in Brussels....In the end, Umberto Bossi, the fiercely eurosceptic leader of the federalist League, made minor concessions that would raise the general retirement age to 67 years by 2026, but rejected changes to Italy’s length of service pension system that allows many workers to retire at the age of 61 with 35 years of contributions. Even Mr Bossi did not sound hopeful that the proposals would go down well in Brussels. In the past he has said he “doesn’t give a damn” about pressure from Europe over Italy’s pension system." He may change his tune once BTPs drop under 90 and go bidless.

With European coverage today about to confirm with absolutely certainty that the only option for Europe is to baffle everyone with intolerable and ridiculous amounts of bullshit, and failing that, to delay, delay, delay (we are already hearing of another summit in 4 days), probably what is most indicative of what to expect out of Europe is what incoming ECB president Mario Draghi said is the situation in Italy which he called is "confused and dramatic." That pretty much sums it up. Anyone expecting any actionable result out of the drama queen country or continent, will be disappointed. In the meantime here are sporadic news which attempt to paint a picture of the total confusion in Europe...

Even our non-polyglot readers will have zero problems understanding the response (in French) by Merkozy, when asked during the press conference, whether Italy, which has the second largest debt load in Europe at $2.2 trillion and inches behind German, will succeed in implementing promised 'reforms.' The wholesale laughter 19 seconds in the the clip, by not only the entire audience, but by Merkel and Sarkozy pretty much explains what the "next steps" in Europe are as the continent has now given up any pretense it is even trying to keep a serious facade on the upcoming serial defaults... and why 10 Year BTPs will need much more than just the SMP, EFSF and the hand of god to stay above 90 in the coming week.

Italy rejected the budget today. I can't imagine that it is because the opposition wanted more austerity. That must make the Slovakians even more eager to provide the EFSF with money to buy Italian bonds. The IMF has declared that they went to Greece (because they had purchased non-refundable tickets) but are going to give our money to Greece even though none of the alleged criteria were met. How long are countries going to let IMF control their money so whimsically? Since EFSF will likely be approved, I wanted to see what the Eurozone was going to do with all that "cheap" money. As you can see clearly from the graph, French bond spreads are widening relative to Germany, and EFSF spreads are widening slightly faster than that.

Fitch Ratings-London/Milan-07 October 2011: Fitch Ratings has downgraded the Italian Republic's (Italy) foreign and local currency Long-term Issuer Default Ratings (IDRs) from 'AA-' (AA minus) to 'A+' (A plus) and the short-term rating from 'F1+' to 'F1'. The Outlook on the long-term ratings is Negative. The Country Ceiling of 'AAA' has also been affirmed. The downgrade reflects the intensification of the Euro zone crisis that constitutes a significant financial and economic shock which has weakened Italy's sovereign risk profile. As Fitch has cautioned previously, a credible and comprehensive solution to the crisis is politically and technically complex and will take time to put in place and to earn the trust of investors. In the meantime, the crisis has adversely impacted financial stability and growth prospects across the region. However, the high level of public debt and fiscal financing requirement along with the low rate of potential growth rendered Italy especially vulnerable to such an external shock.

And here we go again. Ironically, this is nothing. Wait until S&P, which just telegraphed very loudly the next steps earlier, puts France on downgrade review...

As usual, a corrupt and pathetic Moody's continues to boldly not go where everyone else has gone before. Luckily, S&P, which had the balls to cut the US, has just done so to Europe's next domino, by downgrading Italy from A+ to A, outlook negative. Then again, this was pretty much telegraphed 100% earlier today as noted in "Italy Expected To Cut Growth Forecasts Further." Anyway, those incompetents from Moody's are next. Some of the choicest words: "In our view, weaker economic growth performance will likely limit the effectiveness of Italy's revenue-led fiscal consolidation program", "We have revised our base-case medium-term projections of real GDP growth to an annual average of 0.7% between 2011 to 2014, compared with our previous projection of 1.3%", "The negative outlook reflects our view of additional downside risks to public finances related to the trajectory of Italy's real and nominal GDP growth, and implementation risks of the government's fiscal consolidation program" and so forth.