Wolf Richter: Hilarity in NIRP Zone: Italian 2-Year Yield Still Near 0%, as New Government Proposes Haircut for Creditors and Alternate Currency, Markets on “Knife Edge”

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

The distortions in the European bond markets are actually quite hilarious, when you think about them, and it’s hard to keep a straight face.

“Italian assets were pummeled again on mounting concern over the populist coalition’s fiscal plans, with the moves rippling across European debt markets,” Bloomberg wrote this morning, also trying hard to keep a straight face. As Italian bonds took a hit, “bond yields climbed to the highest levels in almost three years, while the premium to cover a default in the nation’s debt was the stiffest since October,” it said. “Investors fret the anti-establishment parties’ proposal to issue short-term credit notes – so-called ‘mini-BOTs’ – will lead to increased borrowing in what is already one of Europe’s most indebted economies.”

This comes on top of a proposal by the new coalition last week that the ECB should forgive and forget €250 billion in Italian bonds that it had foolishly bought.

The proposals by a government for a debt write-off, and the issuance of short-term credit notes as a sort of alternate currency are hallmarks of a looming default and should cause Italian yields to spike into the stratosphere, or at least into the double digits.

And so Italian government bonds fell, and the yield spiked today, adding to the prior four days of spiking. But wait…

Five trading days ago, the Italian two-year yield was still negative -0.12%. In other words, investors were still paying the Italian government – whose new players are contemplating a form of default – for the privilege of lending it money. And now, the two-year yield has spiked to a positive but still minuscule 0.247% at the moment. By comparison, the US Treasury two-year yield is 2.57% over 10 times higher!

Here is the hilarious chart of the spiking Italian yield from the negative into the positive:

“The market will remain on somewhat of a knife edge as regards the intended plans and as the coalition government itself evolves,” Rabobank International analysts wrote in a note, cited by Bloomberg. “The fiscal credibility of the plan is far from guaranteed.”

The market will remain on somewhat of a knife edge… and because of the market is so seriously in fear of a haircut and a default, the yield eases finally into the positive, but barely?

This is an over-indebted government that doesn’t control its own currency and cannot print itself out of trouble and whose new leadership – made up of the coalition of the Five Star Movement on the left and the League on the right – is proposing a haircut for its creditors to make the debt burden easier, and is also proposing the issuance of an alternate currency to give it more money to spend, even as it also promises to crank up government deficit spending and cut taxes too.

So how is it possible the two-year yield was until Wednesday still negative? The 10-year yield is only at 2.35% at the moment. How is this possible?

It has been possible because the ECB, run by an Italian, has been buying Italian government and corporate bonds hand-over-fist, along with bonds from other countries in the Eurozone, as part of its QE, in order to do “whatever it takes,” and what it took was to stop any and all price discovery, and to force investors – such as life insurers and retirement schemes that have to buy euro bonds – to buy Italian bonds even when the yields were negative. These outfits, actually their beneficiaries whose money this is, are now pocketing guaranteed losses. So it’s not hilarious to them.

But the ECB has tapered its bond purchases to €30 billion a month, and will likely end them this year. Leadership at the ECB will change in 2019, and Italy will lose its champion at the ECB. And it’s possible that the new leadership at the ECB might allow some price discovery to happen – at least until Italian government bonds re-implode as they did in 2011, with the 10-year yield above 7%, before Draghi’s “whatever it takes” promise in 2012.

In the US, more changes in the mortgage market may be in the offing. Read… Will the New Fed Get Rid of All its Mortgage-Backed Securities? That Seems to be the Plan

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. Clive

    I do titter to myself when I read the wording most frequently employed by serial pearl clutchers like Bloomberg about policy options which might be considered by a government that are anything but a scraping genuflection to capital. “Populist” being the page in their dictionary that seems to flop open the most readily.

    So what does that make regular vanilla governments? “Unpopulist?”

    Back to Italy: Come back Cristina Fernández de Kirchner. Everything is forgiven.

    1. Eustache De Saint Pierre

      Thank you for that Clive – I have already stolen ” Unpopulist ” to annoy certain individuals on another website – perhaps it will catch on.

    2. Anonymous

      could I get a clue or two on that CFK reference? I don’t think I’ve ever thought about Italy’s and Argentina’s political theaters in parallel, so I’m curious

  2. Susan the other

    good god, Wolf. Do you think there possibly might be an intrinsic contradiction at the heart of finance? Gasp. If Italy went straight to MMT they could skip this ambiguous step altogether and pay for social spending the sovereign way. That dirty word. The question about a parallel currency is: How sovereign is it? And in this mixed up mix it sounds like it is just one step removed from austerity. Because interest paid to some imperial creditors survives. Duh. BOTs are just a face-saving device for both sides. At least the ECB is doing whatever it takes by buying corporate debt and bad debt held by Italian banks. Consider how ruthless the Fed has been – it forbids banks from buying munis (those little critters at the bottom of the finance food chain) and it also forbids them from fobbing off hopeless MBS on the Fed in exchange for liquidity. Where does all this leave us?

    1. Oregoncharles

      Italy would have to get off the Euro to go to MMT. Not only does the Euro mean they are not currency-sovereign, the treaty that establishes it also (I believe – feel free to correct me) forbids MMT-type policies. A provision that QE is designed to get around, because it turns out you can’t really run an economy that way.

      https://www.washingtonpost.com/news/wonk/wp/2018/05/21/italys-new-populist-government-really-might-blow-up-the-euro/: “It didn’t happen the first time, and it might not happen this time, either, but eventually, if the euro keeps giving the continent’s populists so many chances, they will kill it.”

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