Like other Europeans who are not native English speakers, Italians have adopted English financial terms and sprinkle some of them in everyday language. One, “lo spread,” makes me laugh every time I hear it, not just because it is such an un-Italian word (almost all Italian words end in a vowel), but because it’s hard for me to imagine that Italians care about the yield gap between Italian and German bonds. But they do. “Lo spread” had become a quotidian indicator of the health of their country’s finances.
By this measure, Italians should be elated because the spread between Italian and German bonds dipped Tuesday morning to slightly under 300 basis points (100 basis points equals 1 percentage point) for the first time since March as some of the anxiety vanished from the sovereign debt markets in the euro zone’s struggling Mediterranean frontier. Spanish bond yields also fell.
The yield on benchmark Italian bonds is now 4.4 per cent, a remarkable improvement since prime minister Mario Monti launched his “Save Italy” campaign a year ago, when he replaced Silvio Berlusconi. At the time, Italian yields were 7 per cent or higher, a wholly unsustainable level, and Italy seemed on the verge of being shut out of the debt markets, a doomsday event that would have shredded the euro zone. Italy is the region’s third largest economy and has the dubious distinction of having the world’s third largest debt market, after the United States and Japan. Financing Italy would have been practically impossible.
What sent Italian yields down? Mr. Monti’s arrival certainly helped. His austerity and economic reform programs, though still works in progress, have bought a lot of confidence among debt investors. His Italian colleague in Frankfurt, Mario Draghi, president of the European Central Bank, did his bit in August by vowing to do “whatever it takes” to save the euro. Mr. Draghi backed up his promise a month later by unveiling an unlimited bond buying program that has yet to be triggered, though is fully expected to be used to buy Spanish bonds if the Spanish economy continues to deteriorate. The mere presence of the ECB program has calmed nerves.
Finally, the new Greek bailout program, after several false starts, finally appears to be in place, complete with the buyback of distressed privately held Greek bonds at about a third of their face value.
The Italian bond rally has been one of the strongest on the planet, returning about 10 per cent to investors since the ECB announced its bond-buying plan in September, according to various reports. The rally is unlikely to last, if only because rallies by definition are unsustainable, but also because nothing has fundamentally changed for the better in the Italian economy in the last couple of months. The jobless rate continues to rise and the manufacturing continues to go in the opposite direction. The recession is deep and apparently enduring. With a forecast economic contraction of 2.4 per cent this year, Italy’s recession is worse than Spain’s.
There is also the small matter of the Italian general elections, to be held in the early spring. Mr. Monti’s technocrat government is to be dismantled, though Mr. Monti himself has said he would stay if the election were to prove inconclusive. So far, the campaign has been a typically Italian concoction of mystery and chaos. While the centre-left is leading in the polls, the Five-Star movement of comedian and anti-corruption activist Beppe Grillo is coming on strong. Meanwhile, Mr. Berlusconi’s one-again, off-again comeback bid is turning farcical. Still, his effort to come back from the political dead return should not be ruled out.
In other words, political risk is alive and well and is bound to take its toll on the Italian bond markets. Mr. Monti’s goal to leave office with Italian yields at half of the level they were when he was sworn in as prime minister looks ambitious.