Markets deciding: “Financial markets are about trust and confidence. Once you lose those, you are done.”
Law and finance professor Frank Partnoy was talking about the bankruptcy of MF Global, but his words are equally applicable to sovereign bond markets.
Italian prime minister Silvio Berlusconi survived 51 confidence votes and endless sex scandals before soaring bond yields finally seem to have forced him out. Why now, one might ask?
Italian public debt/GDP levels have exceeded 100 per cent for years but yields were consistently lower than Spain’s until July. Japanese debt levels easily outweigh Italy’s, but it pays 1 per cent on its 10-year bonds.
Carmen Reinhart and Kenneth Rogoff’s historical work shows there “is no magic public-sector debt threshold that determines when a crisis hits”, Soc Gen strategist Albert Edwards notes.
The Italian crisis gathered pace after Berlusconi rounded on his finance minister, European leaders dithered and markets lost faith. Forget the Japanese comparison, advises Edwards. “A country is bust when the markets decide.”
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Bond matters: Last July, we cited research by Gary Jenkins at Evolution Securities showing that bond yields can quickly spiral out of control. He reiterated the point this week, noting that Greek, Irish and Portuguese yields averaged 43 consecutive days trading at more than 5.5 per cent before consistently topping 6 per cent; an average of 24 days above 6 per cent before breaching 6.5 per cent; and just 15 days above 6.5 per cent before exceeding 7 per cent.
Italian yields stayed above 5.5 per cent for 40 days and have now topped 6 per cent for eight consecutive sessions.
Citigroup’s Matt King, who warned that “brokers are broken” weeks before the Lehman collapse, notes that feedback loops kick in and accelerate widening, with rising margin requirements for Italian bonds posing a threat.
“Politicians always think they have lots of time,” says Jenkins, “but when the market decides to withdraw support, it can do so very suddenly.”
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Puzzling equities:Equity markets seem blissfully unaware of bond-market panic, with 85 per cent of US stocks above their 50-day moving averages and European markets protecting huge gains.
It’s puzzling the media. “FT Alphaville needs your help,” was the title of a recent Financial Times blog post. Why? “To explain Tuesday’s morning’s price action in European equities.”
Ryan Avent of the Economist is equally puzzled. Equities are higher than in early September, even as the crisis escalates.
“Has the Road Runner sprinted off the cliff but not yet looked down?” he asks.
That’s nonsense, says Nobel economist Paul Krugman. “It’s not the Road Runner who sprints off the cliff – it’s Wile E Coyote!”
