Friday, 22 June 2018

On Italian bonds and other drugs

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Anthony Peters says that Renzi’s Rome will not be built in a day.

Last week I had lunch with another old bond dog at a local Chinese restaurant close to Canary Wharf and a jolly good spread of dim sum was enjoyed. Apart from both bemoaning the devastating cost of divorce and the customary “…then you must also know or have worked with…x… and… y…” we talked about the markets and what might be driving them. The clouds of question marks are probably still hanging over the table. It doesn’t seem to want to get any better.

Mid-morning yesterday a headline crossed the screens reading “Italian 10-Year Yield Drops to 3.67%, Lowest Since Feb. 23, 2006” Around the same time, Bunds were trading at 1.67% so, without needing a PhD in Maths, we can calculate that BTPs were trading at a mere 200bp cheap to Bunds.

By this morning the world had vaguely changed its mind and that spread opens at around 205bp but it does beg the question as to how a country with persistently negative GDP growth, with 42% youth unemployment and with a government which is tearing itself to part can be treated by bond markets as an improving situation. I don’t know what the rates markets are smoking but I suspect it’s illegal; if it’s not, I want some of it too.

It took a quarter of a century to swing this country around and anyone who expects Renzi to be able to perform instant miracles in Italy needs to have a jolly good think

Central bank intervention of the unconventional kind has become the opium of the masses and it remains a simple fact that its main outcome has been to permit us all to continue to live beyond our means. The key idea was, and I take my hat off to the heads of the all the key monetary authorities for their boldness in 2008/2009, to loosen monetary policy in order to give their political opposite numbers time and space to tighten fiscal policy, in other words to bring spending under control.

Instead, to a very large extent, the latter has simply sat back and waited for the near-zero rate policies which the central bankers have delivered to re-inflate the flagging bubble. I recall writing a series of pieces in 2009 which tried to make the point that austerity was not some little, wee passing phase but that it would have to be with us in perpetuity. Five years on next to nothing appears to have been learnt.

So there is Italy with a government in open warfare with itself. Today Matteo Renzi, the leader of the Democratic Party – that’s the centre left to you and me – will openly and formally challenge Prime Minister Enrico Letta. Renzi is just 39 and looks and sounds like the coming man. The Renzi rhetoric is one which points to breaking down the ossified structures of Italian government and opposition and moving it from the 19th into the 20th century and then, eventually, on into the 21st. How he would fare, should he find himself in power, is a different matter entirely.

Eurosceptics would argue that Italy’s internal problems have been compounded by it being locked into the straitjacket of the euro which I only partially agree with. Looking at the UK recovery, for what it’s worth, the liberal labour laws and tacit acceptance by the labour force that one can’t be paid what’s not there along with the free-floating currency which have created a more adaptable economic environment were put in place long before the eurozone came into existence.

It took a quarter of a century to swing this country around and anyone who expects Renzi to be able to perform instant miracles in Italy needs to have a jolly good think. I shall refrain from saying that Rome wasn’t built in a day. If, however, you’re happy to own BTPs at 200bp above Bunds, feel free. I don’t want to own a market that doesn’t know how to price embedded political risk.

Scot free?

Strictly speaking, I should really add that as a reason to sell Gilts too. One reader very kindly responded to my appeal for work on life post Scottish independence but as usual that dealt with an independent Scotland and not with an independent England. Now all three parties have come out and advised that Scotland will have to live without the pound and find its own currency. It doesn’t like the euro any more – you don’t fight for sovereign independence in order to hand it straight back to someone else – and thought it had the right to choose to stay in sterling. Time is coming where all the nice elements of independence have been aired and now the unionists are showing up the downside. Alex Salmond, leader of the nationalist party, is crying foul. Sorry mate, it doesn’t work that way in the real world.

My fear, however, is that Salmond hopes to lose the vote but still be left with the moral right to fight for more devolution from London. I don’t like the pick and choose approach he takes and would rather see the Scots, for whom I have great fondness, go it alone than watch Salmond chisel away taking the good bits and leaving the bad.


Finally, for me it is that time, not only of the week but of the year, when I pack my bathers and sunnies and flee the cold, wet of Europe for a couple of weeks. All that remains is for me to you and yours a safe and happy time here. May you neither get washed away nor drowned in the white stuff and I look forward (not) to landing back in London on March 1st to spring sunshine and flowering daffodils.

My last decision will simply need to be whether I take the boat or the car from here to the airport.

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