NIRP’s Revenge: Italian Bonds Plunge, Worst Day in Decades

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Yves here. While Mr. Market got in quite a tizzy today over 5 Star and Lega’s abandonment of their effort to form a coalition government after the President Sergio Mattarella nixed their choice of economy minister, Paolo Savona. This has produced a first-class political crisis. The technocrats, in trying to appease Mr. Market, has done the reverse.

Mattarella is planning to form a caretaker government and wants it to pass a budget and then hold elections, which would have the convenient effect of tying the upstart, wannabe deficit spender populists from getting their hands on the fiscal spigot for another year. Mattarella doesn’t have the votes in Parliament to carry this off unless some members of the failed coalition lose their nerve.

Talk last night was of elections in the fall. Talk of yesterday was that they might be held as early as July. But we also are in the midst of what Lambert calls an overly dynamic situation. For instance, as we anticipated, 5 Star has officially abandoned its talk of impeaching Mattarella.

And as of late evening in Italy, the head of 5 Star, Luigi Di Maio, broached the idea of reviving the coalition with Lega and prevent the need to hold new elections.

Even though this excerpt comes from an article in Bruegel that was published by the Peterson Institute, one can read past the editorializing and hoist useful recaps, such as this summary of the major economic policies of 5 Star and Lega, and estimates of their fiscal impact:

M5S and League’s electoral promises are both centered on a more expansionary fiscal stance, although with major differences. M5S promised the introduction of a minimum guaranteed income—which appealed to voters in the economically suffering south. The League party promised a flat tax—which appealed to voters in the economically thriving north. Both parties advocated the repeal of a controversial pension reform introduced in 2011 by the government of former prime minister Mario Monti. The government contract between the two parties features all three promises. Moreover, both parties have committed to repeal an otherwise automatic hike in the value-added tax (VAT) planned in the 2018 budget.

How much would this largesse cost, and how might it be financed? Repealing the VAT hike would require €12.5 billion. As for the other promises, Carlo Cottarelli at the Osservatorio Conti Pubblici Italiani estimates that the League’s flat tax would cost around €50 billion, while M5S’ guaranteed income would cost about €17 billion. Scrapping the Monti government’s pension reform would add a further €8 billion. Counting in some of the minor promises, the total would reach a whopping €109-126 billion (6 to 7 percent of GDP).

Since Italy is running a primary fiscal surplus of roughly 1.5%, this would imply a primary deficit of 4.5% to 5.5% of GDP. While that is arguably just a good big fiscal shot in the arms for a depressed economy, Italy’s deficit in 2017 was 2.3% of GDP, so adding in as much as another 7% of GDP in spending takes it to a nearly 10% of GDP deficit. Those are hair on fire levels to neoliberals and financial markets types. If you take the MMT point of view, Italy is a long way from being inflation constrained, but Italy isn’t a currency issuer and investors would exact a high interest rate to fund this level of deficit spending.

Some additional things to keep in mind. From Thomas Fazi, on why the Eurozone has ground Italy down economically:

As insightfully argued by Fritz W. Scharpf, former director of the Max Planck Institute for the Study of Societies (MPIfG), the euro regime can be understood as a process of “enforced structural convergence,” aimed at imposing the northern export- and profit-led economic model (well represented by countries such as Germany and the Netherlands) upon the very different political economies of southern countries, such as Italy, which tend to be much more internal demand– and wage-driven. Scharpf notes that “the economic impact of the present euro regime is fundamentally asymmetric. It fits the structural preconditions and economic interests of northern economies, and it conflicts with the structural conditions of southern political economies—which it condemns to long periods of economic decline, stagnation, or low growth.”

And going from the strategic to the tactical, from roversi1968 in the Financial Times’ comment section:

Three main facts to consider:

1. The Five Stars movement had threaded very cautiously over immigration issues before the Italian elections last March – so much so that a lot of disappointed centre-left voters decided to trust them and moved consensus from the centre-left to the Five Star movement. The Lega Nord on the other hand campaigned for – and indeed proposed they would if they went to power –  enforce the deportation of as many as 500,000 immigrants.

2. Mr. Berlusconi is back in the game after a tribunal decreed his good conduct makes him fit for office again.

3. After the vote in March Mr. Renzi actively kept the Centre-Left away from a coalition with the Five Stars movement – which alienated a lots of their voters – who did not understand why they had given a vote to a Party who refused to go to power.

So now – in the centre-left – either:

A1. The Five Stars align themselves with the Lega during the new electorial campaign, and in joining the open xenophobia they reveal true colours that are unpalatable to former centre-left voters – who will go back to vote centre-left, or:

A2. The Five Stars movement keep their separate campaign, they keep the former Centre-left votes, and will do well – perhaps even better than the last time.

And – on the right – either:

B1. The Lega Nord breaks the electorial alliance with Mr. Berlusconi who will likely lose votes to them, or

B2. The Lega Nord and Mr. Berlusconi keep their alliance – and Mr. Berlusconi will weaken the Lega

Either way B1 or B2 the right will stay the same or be weakened,

To me, it seems the decisive factor is what the Five Star movements will do. If they run with the Lega, the centre left will come back to win more relevant parliamentary numbers and become a more likely governmental party. Especially if the sideline Mr. Renzi completely.

If the Five Star keep their own campaign separate from the Lega, they will likely increase their majority and may be able to form a goverment on their own.

And readers who nurtured hopes that the Bank of Italy might run the printing press in Italy to make more euros for the government, or provide liquidity to Italian banks in defiance to the ECB should take note of these remarks quoted in the Financial Times, which are consistent with our comments as to where the central bank’s loyalties would lie:

The comments by the governor of the Bank of Italy, Ignazio Visco, were unusual for an institution that rarely ventures into politics….

“The rules of the game can be debated, even criticised; they can surely be improved,” Mr Visco said in an annual speech on the state of the Italian economic and financial system. “Yet we cannot disregard constitutional constraints: protecting savings, balancing the accounts and respecting the treaties.”

Finally, to Wolf’s post. While he has a point in arguing that Italian interest rates have simply renormalized with impressive speed, the counterargument is that the Italian government can’t afford even modestly higher interest rates. Mind you, I haven’t seen any serious analysis supporting that claim.

And let us remember, as Robert Waldmann pointed out at Angry Bear, in Investors Not Pleased With Italian Politicians:

This isn’t a crisis yet. I recall back when Italia caught a bit of Greek contagion (before ECB president Mario Draghi said “whatever it takes”) that the experts at the tesoro said they could handle interest rate spreads up to 7% (it got close back then)

By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street.

Markets wail and gnash their teeth as “normalization” of Italian yields sets in.

On Tuesday, Italian bonds had their worst day in Eurozone existence, even worse than any day during the worst periods of the 2011 debt crisis. And this comes after they’d already gotten crushed on Monday, and after they’d gotten crushed last week. And this happened even as the ECB is carrying on its QE program, including the purchase of Italian government bonds; and even as it pursues its negative-interest-rate policy (NIRP). As bond prices plunge, yields spike by definition, and the spike in the two-year yield was spectacular, going from 0.3% on Monday morning to 2.73% on Tuesday end of day:


But note that until May 26, the two-year yield was still negativeas part of the ECB’s interest rate repression. On that fateful day, the two-year yield finallycrossed the red line into positive territory.

To this day, it remains inexplicable why the ECB decided that Italian yields with maturities of two years or less should be negative – that investors, or rather pension beneficiaries, etc., who own these misbegotten bonds, would need to paythe Italian government, one of the most indebted in the world, for the privilege of lending it money. But that scheme came totally unhinged just now.

The 10-year Italian government bond yield preformed a similar if not quite as spectacular a feat. Over Monday and Tuesday, it went from 2.37% to 3.18%:


But here’s the thing: Italian bonds – no matter what maturity – should never ever have traded with a negative yield. Their yields should always have been higher than US yields, given that the Italian government is in even worse financial shape than the US government. Italy’s debt-to-GDP ratio is 131%, and more importantly, it doesn’t even control its own currency and cannot on its own slough off a debt crisis by converting it into a classic currency crisis, which is how Argentina is dealing with its government spending. The central bank of Argentina recently jacked up its 30-day policy rate to 40% to keep the peso from collapsing further.

That’s the neighborhood where Italy would be if it had its own currency. But the ECB’s QE shenanigans and NIRP drove even Italian yields below zero, and so now here is NIRP’s revenge.

But just a little. In fact, Italian yields are in the process of “normalizing,” but they’re doing it swiftly, rather than “gradually,” as the Fed likes to emphasize at every opportunity for a very good reason: It took the Fed over four yearsto push up the two-year Treasury yield by 210 basis points. Italy accomplished the same feat in less than two days.

OK, normalization can be painful after years of NIRP. But just today – on the worst day for Italian bonds in Eurozone history – the government was able to sell €5.5 billion ($6.4 billion) six-month bills maturing in November 2018, at an average yield of 1.21%.

Let that 1.21% stew for a moment. In the US, today, the 6-month yield closed at 2.06%! So the Italian government is still borrowing at a lesser cost than the US government. Italy’s yield normalization has a long ways to go!

This was up from a negative yield of -0.42% at the prior six-month auction at the end of April. Oh my, how it hurts to have to pay interest on borrowed money, rather than getting paid for borrowing. I can hear the wailing and gnashing of teeth in Rome and in the markets around the world.

This six-month yield had reached an all-time high of 8.65% in November of 2011 and an all-time idiotic low of -0.48% in November last year. It needs to be way higher than it is today to account for at least some of the risks.

This yield normalization – or bloodbath, as others call it – comes on the heels of the failure of two anti-establishment parties, one on the left, the other on the right, to form a coalition government. They’d proposed to just blow off €250 billion of Italian bonds that the ECB has stupidly acquired, introduce an alternate currency, cut taxes, and raise spending.

If this plan had come to fruition, government bond yields would have spiked into the double digits, and a real default with big haircuts for investors would have been all but certain at those yields. Now the plan is off, the coalition hopes are in shambles, new elections are likely, and Italian voters get to sort this out, once again in their manner, in the voting booth.

The “doom loop” begins to exact its pound of flesh. Read… Which Banks Are Most Exposed to Italy’s Sovereign Debt? (Other than the Horribly Exposed Italian Banks) 

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  1. Luxy

    [And readers who nurtured hopes that the Bank of Italy might run the printing press in Italy to make more euros for the government, or provide liquidity to Italian banks in defiance to the ECB should take note of these remarks quoted in the Financial Times, which are consistent with our comments as to where the central bank’s loyalties would lie]

    With pressure applied on the right place, loyalties change.
    Eventually, people can be changed too…

    1. Yves Smith Post author

      *Sigh*. There a significant amount of IT in any central bank. If you threaten the staff, they will quit and maybe even flee. You are left with no one or not enough someones who know enough to do much of anything.

      1. Yassine

        Why would you need to threaten the IT staff ? I see no obvious reason to think that the (misplaced) loyalties of the central bank’s upper management would be shared by the IT staff…

        1. Clive

          The original point (such as it was, it was risible) was that you could be coercive and create incentives for people — civil servants and bank employees in this example — to rethink their attitudes. Presumably that the Italian Central and commercial banks could learn to stop worrying and love a newly-reissued national currency.

          Anyone who thinks that has obviously never worked in a bureaucracy. You can certainly influence the 0.1%’ers in the top echelons either by promising them goodies or implied (or real) reprisals. But the rank and file have an infinite array of mechanisms to sabotage the organisation. Feigning ignorance, slippery desking, losing documents or materials, introducing hidden slow-burn errors, pulling sickies… the list is endless.

          The old Soviet Union didn’t collapse because of gulags, torture or repression nor was it brought down by protesters in the streets — although all these elements were present. In the end, the people merely developed undetectable means of being passively uncooperative.

          And even on a good day, my TBTF (to give an indication of what you’re up against) is staffed by a so demoralised, uninspired and generally fed up workforce, it can scarcely stagger along more-or-less treading water. During the GFC, it resembled nothing so much as a headless chicken on Xanax.

          People way over estimate organisational resilience, especially under the stresses resulting from the kinds of conditions postulated here.

          1. animalogic

            The opposite is true as well.
            A fair proportion of early Nazi success was due to the cooperation of a highly professional German public service.

          2. Yassine

            What I was hinting at was the possibility of playing the rank-and-file (in particular the IT staff) AGAINST the upper echelons of management and not even trying to get an ideologically hostile management on board with the plan.

            I am increasingly convinced by personnal experience and anecdotal evidence gleaned on the internet that the success rate of a complex IT projects is inversely correlated with the level of involvement of non-technical management and this would play into increasing the likehood of success of such a scenario.

            Moreover, I could argue that the “demoralised, uninspired and generally fed up” state of the workforce and the “infinite array of mechanisms to sabotage the organisation” that they have at their disposal is a positive aspect in this scenario, as it would prime the rank and file into betraying management, especially if you frame the plan as a mixture of “helping the little guy” and “helping your country”.

            To be clear, I am not saying that this scenario would be a “walk-in-the-park” or even feasible without careful and detailed planning and a few lucky breaks. I also completely understand the irritation and frustration created by the armchair coders glossing over the IT challenges associated with any country leaving the euro but, IMHO, what started as legitimate grievances in the Syriza context has, in time, turned into a sort of TINA attitude on the subject that is as unwarranted as the oversimplification it puported to combat.

  2. Dugh

    Paying the thermodynamic piper. Renormalization is going to be a bitch after nearly a decade of central bank perpetual motion machine shenanigans.

  3. The Rev Kev

    So I guess that having another Prime Minister like Monti come in and appoint a technocratic cabinet made up of professionals is out of the question now like happened back in 2011? No more putting bankers in charge of Italy to keep the bond market happy? From what I am given to understand, the Italian economy is far too large to consider making it another Greece. Likely the Italians know that Brussels cannot afford to push them too hard. I would have thought that Spain’s economy would have blown up first so I guess that I was wrong here. That is, unless the debacle of TSB bank works its way back to Sabadell in Spain and starts blowing up Spain’s economy.

  4. Ignacio

    Political crises are cascading in southern Europe. Next friday spanish parliament will be voting a motion of censure settled by PSOE against the conservative party. Remarkably, it could be the first one that succeeds in the history of our young Constitution. It is also interesting to note that independentist Puigdemont (PdeCat) does not support the motion. This shows how confortable is he with current confronting dialectics with his spanish nationalist peers. In turn, PdeCat position migth decissively push anti-independentist Ciudadanos to support the motion. This motion is the consequence of a recent judicial resolution on the most important corruption scandal “Gürtel affair” involving the ruling conservative party (PP). The PP is doomed and will –hopefully– soon be replaced. I cannot tell but in case of snap elections the new ruling party could be Ciudadanos (Macron-like) or a left coalition (PSOE-Podemos-IU). An anti-EU government can be ruled out in Spain. It is weird how similar situations in Italy and Spain lead to very different political outcomes and this explains why southern countries do not confront together germany-driven EU policies.

    Anyway the point I was trying to make is that in both Italy and Spain, political parties and institutions are all playing tactical games and you cannot see what the political direction will be, if any. Politics is now a guerrilla game.

    1. PlutoniumKun

      If they lose the motion does this mean there has to be an election, or would it mean a potential new coalition?

      1. Ignacio

        If the motion is lost Rajoy remains until the end of the legislature. Doing nothing as usual.

        1. Ignacio

          If it wins there should be a short interim government and elections. Not clear if as soon as july or in autumn. Most probably in autumn.

          1. PlutoniumKun

            I wonder if there are any possible good outcomes of an election. Is there any possibility of PSOE and Podemos forming a ‘sensible’ anti-austerity coalition?

            1. Ignacio

              It looks that Podemos is interested and current PSOE leader somehow leans to the left of his coreligionists. So there is a possibility.

  5. Disturbed Voter

    Great analysis. Either Germany relents its mercantilism or we see Ital-exit.

    US EU policy has always been pro-GB and pro-Germany … this may have to change.

    1. Yves Smith Post author

      The US has now succeeded in pissing off all of Europe, with stunts like exiting the weak Paris climate accord and now the Iran nuclear deal. And Trump and Bolton have made clear they aren’t very interested in multinational or EU institutions. So the US will sit this one out.

        1. Clive

          And Canadian / British (NI) interests.

          This was later walked back (like so much else) but it shows the current US administration’s unfailing ability to lose friends and alienate people.

  6. lou strong

    AFAIK, with some approximation and in extreme synthesis , Italian bonds offered negative real interest rates in the turbulent seventies, and started offering good real interest rates in the eighties , but until the nineties the fact was mainly an internal business with obvious redistributional effects among internal savers/investors .Then since the nineties the business and the profits around it became progressively ( with some stop and go ) more internationalized, partially in parallel with the expected redenomination in a strong currency, and it went on until recent NIRP and all the situation deprecated by wolfstreet. It breaks my heart to hear the wail of the investors.

  7. Tony Wright

    Hmm, “not very interested in multinational or EU institutions”. So does that mean that the US under Trump is adopting a general strategy of divide and rule? Or perhaps more accurately, bully individual countries into one-sided trade “deals”, rather than negotiate more complex multilateral deals where each country benefits to some extent.
    What was it Trump said once? – ” the golden rule of negotiation – he who has the gold makes the rules”.
    Civilisation’s rule of the jungle I suppose.

  8. Susan the other

    I’m not being flippant here – Europe is just driving me nuts. The “export model” of German EU tyranny always screws somebody somewhere (Steve Keen recently). Even Schaeuble said “we can’t all export our way out of this”, and “we are overbanked.” Imposing a structural mercantile model versus a domestic demand-wage model is the problem. And a monetary phase change is the solution: (pure MMT I guess) If there is a demand for social benefits and domestic distribution it doesn’t mean “deficit” except to the ECB’s looney balance sheet because domestic economic prosperity isn’t “debt” – it’s just a monetary phase change. If “protecting savings” i.e. the value of the euro or lira, is important to the oligarchs then they should get with the program. We give everybody a guaranteed job/income – the populists get a paycheck for doing environmental work and the oligarchs get a guaranteed return on their environmental investments which can be “greens” that can be cashed in for any sustainable item; and we can still give them their proverbial pat on the back for being such noble job creators. Or something like this.

    1. Clive

      Try living here! It’s like I’m stuck in that god awful movie Star Wars: Episode I – The Phantom Menace — with the EU typecast as the embryonic Evil Empire. But then the supposed “heros” are so unsympathetic and spoiling every other scene when they keep blathering on idealistically but sadly inaccurately about trade treaties and independence at every opportunity parroting a bad script with bad acting and in such a bad plot that you keep wanting to jump into the screen to tell the stormtroopers where the whiney kid is hiding, just so it’ll all be over a bit quicker.

      1. susan the other

        we should coin some new words and phrases for this manic phase of denial the world is in

    2. Eustache De Saint Pierre


      I think it was Jacque Sapir who pointed out quite a while ago, that Germany needs to keep the EZ show on the road because if it were to break up & all the other countries were to devalue their currencies, the Germans would then become much less competitive. I might have this wrong but in any case, if it does all eventually fall asunder it could perhaps be partly attributed to the fact that if the construct were likened to a family group, the rigidity & strictness of the Patriarchal Fatherland to weaker members & those who struggle against the unfair constraints applied on them, finally figured enough is enough & despite the risks, got the hell out.

      I also believe that Taleb considers Germany to be fragile & Italy being well used to chaos as antifragile – perhaps we will find out if he is correct, but I suppose that it all depends on the particular circumstances involved.

      1. Oregoncharles

        Italians built the 3rd largest economy in the EU while being called “the world’s only functioning anarchy,” so yeah, antifragile.

        (I assume the size reflects population, but it doesn’t reflect 3rd-world status or failure to cope.)

    3. Ignacio

      Susan, could you please come here and tell this very same to our lovely technocratic drones (ups, eurocrats)?

  9. Jim Haygood

    Italian bonds – no matter what maturity – should never ever have traded with a negative yield.

    As Bill Clinton might have said, it depends on what you mean by ‘traded.’ In its still-underway QE program, the ECB has a self-imposed limit of not buying more than one-third of any EZ nation’s bonds — a huge chunk of the market, given that many of those bonds were already outstanding when the program began.

    Fortunes were made in the 1990s on the great European bond convergence trade, in which formerly high-yielding bonds from the habitual Club Med currency devaluers were pulled into the orbit of German bunds, at only a small yield spread above them.

    As long as EZ nations don’t do anything radical on the financial front, negative yields on German bonds necessarily pull yields down in all the rest of the euro zone. But if Italy cuts loose with either a parallel currency or massive fiscal deficits, then it becomes a special case and Italian yields must rise to levels that are comparable to other medium-sized non-EZ nations — though Italy is in a class by itself at 132% debt to GDP.

    When sovereign debt goes above 100% of GDP — as it has in both the Italy and the US — growth slows to a crawl as the people mutter in resentment and vote for populists brandishing sledge hammers.

    1. John k

      Not comparable. Us debt owed by us us sovereign, sovereign can pay any debt in its own currency… and therefore determines what interest, if any, it pays on risk free bonds… as demonstrated by Qe, when more were bought than issued. Fed could just burn all the treasuries it buys, no need to balance books. And even with the various self imposed constraints palt coin can be used to balance fed books if desired.

      Italy owes debt in euros, can’t print. Eu always going to be disaster for club med, Greece dead, Italy on deck. Longer they delay exit the worse it will be.

      1. Wukchumni

        Gordon Brown liquidating @ the bottom of the market for the barbarous was a tell, if there ever was one, in retrospect.

  10. Oregoncharles

    I wish I could get 2.73% on a loan. Not an impressive number. It’s just the direction that is sinister.

    Of course, the whole situation just underlines the silliness of having monetary policy controlled outside the country, with no fiscal unification. Who thought that might work?

    Which is pretty much what Yves said.

    Just a classical note: Scylla and Charybdis, the proverbial “rock and a hard place,” are in Italy – the Straits of Messina.

    1. Synoia

      Of course, the whole situation just underlines the silliness of having monetary policy controlled outside the country, with no fiscal unification. Who thought that might work?

      The Germans. And it does work for them.

  11. John k

    Lega vs star…
    Lega has been rising in polls, not Star. Ejecting immigrants likely pop, and does not increase deficit, which many are fearful of, not least because confrontation with central bank.
    Agreed star should campaign separately for stated reasons, doubtful they increase votes even though Italians resentful of ecb and Germany… rising rates raise fears.

  12. Synoia

    Cheer up, they said.
    It could be worse.

    So I cheered up.
    And it got worse.

    All I have to offer is sardonic humor.

  13. Salmo Trutta

    I am the Alpha and the Omega. I cracked the code in July 1979.

    Unless the DFIs are driven out of the savings business, the U.S. will undergo a protracted economic DEPRESSION.

  14. David Cotton

    What should the yield on Japanese bonds be? Public debt of 240% of gdp and rising. Running a public deficit every year since the early 90s.

    What is the difference between Japan and Italy?

    The Euro is the problem. If Italy had debt denominated in it’s own currency it would not have any bond yield issues and its bonds would trade like JGBs.

    The Euro and Europe governed from Brussels is the crux of the issue. 20 years of the most moronic stupidity. Leading to Brexit and this totally unnecessary crisis. In the late 90s Europe was doing great and it’s been totally ******.

    Things aren’t even bad yet. We’re at the top of the economic cycle. What happens when Europe is in deep recession in 6-12 months?

    Hopefully the end game will be btter than in the early 20th century at least.

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