While many will point to the drop in front-end Italian bond yields as proof positive that all is well in the still-peripheral nation, we note that today saw 10Y Italian bond (BTP) spreads crack back above 400bps for the first time in 3 weeks and nervously remind readers of the stock market reaction in Eastman Kodak a week or two before its death. Of course, Italy is perhaps not quite as imminently terminal as EK was (thanks to the ECB reacharound) but the excitement about BTP's 'optical' improvement will be starting to fade as banks are underperforming dramatically, we have exposed the sad reality of the LTRO, and now even the short-dated BTP yields are now over 40bps off their tights from last week. Why? Deutsche Bank's Jim Reid may have the answer that Italy has now been in recession four times in the last decade and while hope is high that the new austere budget will take the nation to debt sustainability, he notes that the cumulative forecast miss since 2003 on GDP estimates is approaching an incredible 20%. As Reid notes, "When debt sustainability arguments are finely balanced and very dependent on future growth the question we'd ask is how confident can we be that economists’ forecasts are correct that Italy will pull itself out of the perpetual weak and disappointing growth cycle seen over the last decade or so." As we (ZH) have been vociferously noting, LTRO did nothing but solve a very short-term liquidity crisis in bank funding, and the reality of insolvent sovereign and now more encumbered-bank balance sheets is starting the vicious circles up again. Deutsche's base case remains that peripheral growth will disappoint and the sovereign crisis will re-emerge shortly - we tend to agree.
From top to bottom, we see 10Y BTP spreads wider by 65bps in the last week, 10Y yields higher by 47bps and 2Y yields higher by 44bps.
Deutsche Bank 'Early Morning Reid'
In terms of yesterday's European data it was a day of emphasizing the gap between the core and peripheral in terms of growth. Germany's Q4 GDP fell a less than expected -0.2% vs -0.3% consensus, and France grew by 0.2% vs -0.2% expected. However Italy (-0.7%) was
slightly weaker than expected (-0.6%). Indeed the negative print in Italy confirms the 4th recession since 2001. Indeed in today's EMR we show these 4 recessions in Italy graphically in the first chart and add an additional couple of graphs that we think need to be seriously taken into account when thinking of the country's economic future and that of the entire periphery.
We've previously shown that Italian nominal GDP has still failed to recover from its 2007/08 peak and with austerity now starting we wonder whether economists are being too optimistic about the chances of the country returning to growth beyond the first half of this year. Over the last decade market consensus has generally been overly optimistic on the state of the Italian economy (as with many others in the developed world to be fair).
In the second graph we have plotted the consensus forecast for long-run real growth several years out for each year from 2003 onwards alongside the actual outcome. The graph clearly shows that actual GDP has consistently undershot these forecasts. The third graph then shows a crude cumulative forecast miss from each of these years. The cumulative real GDP miss from 2003 to the present day is approaching 20% and is close to 10% since 2008.
When debt sustainability arguments are finely balanced and very dependent on future growth the question we'd ask is how confident can we be that economists’ forecasts are correct that Italy will pull itself out of the perpetual weak and disappointing growth cycle seen over the last decade or so. Those of a more optimistic persuasion will point to the hope of success in the long overdue reforms now in place. However will the effects of austerity offset this?
Only time will tell but our base case is that growth in the periphery will continue to disappoint the consensus for many quarters and years to come and that the sovereign crisis will continue after what might be a benign first few months or even first half of the year.