Thursday, December 29, 2011

Buon Anno

Yesterday’s sale of short-term Italian debt saw rates cut in half compared with the last auction in November.  While the drop on the yield for 6-month bonds to 3.25% was welcome news (though still over a percentage point higher than comparable bills sold ten days ago in Spain) and sent the Euro and markets up slightly, it is irrelevant in the larger picture of Italy.

Today’s more important auction of 10-year notes is a better gauge of sentiment and was widely anticipated. While borrowing costs dipped to just a shade under 7%, the level considered unsustainable and at which other countries have needed bail-outs, the results were both disappointing and worrisome.  The Italian Treasury faced lackluster demand and was unable to sell what it had hoped, raising about €7 bn instead of its target of €8.5 bn. Rates rose again above 7% after the auction and traders claim that the ECB is stepping into the secondary market, buying bonds to stop yields from increasing further. This continued uncertainty in the largest of the Eurozone's troubled economies sent the euro to multi-year lows against the dollar and the yen.

Mario Monti proclaimed himself relieved that yields were falling but was sharply critical of investors and to some extent his EU partners. Saying that Italy was moving in a direction “toward Brussels and far away from Greece” Monti argued  that given the fundamentals of the Italian economy, there was no justification for the spread with German bonds, which has crept back up over 500 basis points.

But Monti’s, and Italy’s, problems are not likely to be over any time soon.  Business confidence in Italy is falling faster than bond yields and has hit a two year low, announced the national statistics institute today.  This follows on their Christmas Eve message that consumer confidence has fallen to a 16-year low, which helps explain the 13% drop in movie attendance over the holidays in Italy and the worst season for retailers in a decade. 

While Monti still has not given details of the reforms he will propose early in the new year, his focus on the pension system and tackling Italy’s dual labor market by easing restrictions on hiring and firing puts him on a collision course with the trade unions. Without parliamentary support from the main opposition, the PD (Partito Democratico), which is influenced by the largest trade union, the CGIL, Monti will find it tough going to get his reforms passed.  That, in turn, is likely to spook the markets and send the country’s borrowing costs to unaffordable levels.

Buon Anno?  Not for Mr. Monti.

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