The adjustment on the upside is not over on Italian rates. The 10 year bond’s rate is converging to 3%. The spread with the German 10-year rate is now circa 270 bp. This also reflects a safe heaven effect for German bonds.
With a rate at 3% % while the inflation is at 0.5% (in April), the real rate is way too high in Italy compared to real growth prospects. But such a level on the real rate (2.5%) would be just above the average seen since the beginning of the Euro Area (2.2%). It’s too high when the GDP trend is close to 1%. This has deterred investment and it will continue limiting the capacity to grow. We have to expect a slowdown in the economic activity in coming months. It will come from the real rate level but also from the uncertainty in the Italian economy. An austerity program that can be expected from a transition government is not good news for Italy but also for the rest of the Eurozone.
This map reflects questions about the sustainability of a government when constituents of it belong to regions and communities that are in a historical conflict. A real source of uncertainty
Judging by the Italian president Sergio Mattarella’s (justified) refusal to approve a government that would have been dominated by the League with its aversion to Europe and its institutions, the forthcoming parliamentary elections in Italy will focus on the euro and Italy’s membership of the euro area.
The worrying point here is that the Italian population is no longer in favor of the euro, as shown by the latest European Commission Eurobarometer survey (October 2017), when 40% of Italians said that the euro is a bad thing for the country as compared to 25% of the population in the euro area as a whole, and also in France. Meanwhile, only 45% of Italians think that the euro is a good thing for the country vs. 64% on average in the euro area and France. The European question played a major role in the French electoral campaign in spring 2017, but we can see that the European aspect of the Italian elections was driven by different considerations. Close to half of Italians are skeptical on the usefulness of the single European currency, and herein lies the real difference. Continue reading
The Italian situation becomes more complex after the resignation of Prime Minister Guiseppe Conte. The Italian president didn’t validate the government Conte has presented to him.
In this possible government, Salvini, the leader of the League, had the Ministry of the Interior and Di Maio, the 5-star movement’s leader, the Ministry of Labor. These points were recorded.
The stumbling block was the Ministry of Finance, where Paolo Savola, who is very critical of the euro and the construction of Europe, was being approached. Continue reading
The lull in Italy after Conte’s appointment was short-lived. The 10-year rate is up sharply while the German rate retreats. The spread is increasing. The Salvona hypothesis for finance minister does not satisfy because of the systemic risk associated to him
Co-authored with Zouhoure Bousbih
The dollar has been gaining ground since mid-April, with investor perception that the Fed would take stronger and swifter action than expected, and this raises a number of difficulties for emerging markets.
The greenback’s surge against all other currencies is a game changer for emerging countries for at least three reasons: expectations of a swift rate hike from the Fed generally trigger capital outflows from emerging countries, which is what we are currently witnessing; the situation also hampers economic prospects due to insufficient liquidity and the ensuing rise in interest rates; these factors combine to further push the currency down and thereby increase the cost of paying off dollar-denominated debt (read my posts here and here to find out more about this deterioration).
This situation is particularly worrying when the current account balance (which reflects a country’s external relationships) displays a deficit, as the flipside to this is high external debt and a situation that is set to deteriorate even faster than elsewhere. This raises the question of financing the current account at a time when the country is suffering capital outflows, and the country in question generally has to up its interest rates considerably, pushing its economy into a downward spiral and ultimately locking it into a crisis.
We have witnessed this situation recently in Argentina, Turkey, Indonesia, South Africa and some other countries, and there is nothing unusual about it, but it is very a costly experience for countries hit by this adjustment.
At this juncture, I feel it is interesting to identify the mechanisms involved in this type of crisis by taking the example of Turkey. The country is currently undergoing this type of adjustment in a very dramatic way and the situation is made even more complex by the prospect of early presidential elections on June 24.
The Turkish crisis Continue reading
Giuseppe Conte’s appointment is the first reduction of uncertainty in Italy. The 10-year rate falls back this morning and the spread with Germany is narrowing. But this is only a first step. Now there is the formation of the government and it will be another matter.