Italian Debt Is Unsustainable – EUR/USD Extends Drops

Italy’s bond auction is very worrying, that the ECB jumped in and bought Italian bonds immeidately after the auction. While there are some improvements from previous long term auctions, the bottom line is that the burden of debt continues growing, while the economy is heading in the other direction.

This is unsustainable. EUR/USD drops and aims for a new year-to-date low. Update: EUR/USD broke to a new YTD low, at 1.2867 at the time of writing.

10 year bonds are often the benchmark. Among the wide range of bonds auctioned, here are the ones close to 10 years:

Euros    1.176bln   of 4.75% Sep 2021 BTP, btc  1.579     (prev 1.48) , yield   6.70   %  (prev 5.77%)

Euros      2.5bln  of 5% Mar 2022 BTP, btc    1.357      (prev 1.34)  , yield  6.98   %  (prev 7.56%)

Looking at the first line, we see a rise in the yield, so there’s no improvement whatsoever. The second line, for debt that is a bit more far away, provides some hope: the yield dropped.

But wait: it’s still around 7%. This is the “bailout barrier” for Greece, Ireland and Portugal. The hope is that Italy can grow itself out of the current mess. Yet also here, Italy’s economy contracted in Q3 by 0.2%., while the euro-zone still grew. Italy is ahead of the zone in entering a recession.

Lower growth means less income from taxes and a need to raise more money in the markets. With these yields, each auction just raises the debt-to-GDP ratio, that is at around 120%.

The massive LTRO operation by the ECB was supposed to encourage European banks to buy sovereign debt, among other purposes. They get cheap money from the ECB in return for collateral, such as Italian debt.

But Italy didn’t even managed to cover the maximum amount it wanted to raise. It raised 7 billion euros in total, while a maximum of 8.5 billion was set.

Apparently, this isn’t enough to lower the yields. It was good enough for Spain (that has a lower debt-to-GDP ratio, but not for Italy – the zone’s third largest economy.

EUR/USD is struggling with 1.29 once again, close to the 1.2886 lows it reached earlier, and close to the year-to-date low of 1.2873.

For more on the euro, see the euro dollar forecast.