Monday, July 18, 2011

The Vampiro Calamari Answers 10 Questions on Italy (GS)

Both the story and the idea for the headline are from FT Alphaville:
Got questions? Goldman has answers.
The calamari bank — like most of the market — turned its attention to Italy late last week. In particular, economist Lasse Holboell Nielsen took some time to answer 10 “key questions” on the Italian situation.
Here they are:
1. Why has the crisis spread to Italy?
This is not entirely clear, nor is it clear why the sell-off has occurred now.
External risks facing Italy appeared to have eased with the adoption of additional austerity measures in Greece, and after the Euro-group and the IMF signed off on a fifth tranche of financial aid to Greece last week. However, this was offset by a number of factors, which probably exacerbated negative investor sentiment: (i) concerns over a lack of agreement on a new support package for Greece, and in particular the role of private-sector involvement, (ii) the likelihood that rating agencies would treat any private-sector involvement in a Greek debt restructuring as tantamount to a selective default, (iii) related to this, the ECB’s continued opposition to private-sector involvement and its refusal to repo collateral with a selective default rating, and (iv) the severe downgrading of Portuguese sovereign debt, driven largely by concerns over private-sector involvement and its implication for Portugal’s future market access.
Although Italy had, until recently, been relatively insulated from concerns over the debt crisis in Greece, specific Italian factors are likely accountable for the timing of the recent market sell-off. The Italian government’s potential inability to deliver necessary budget cuts added to concerns over the back-loading of austerity measures under the current budget. On top of this, Italy’s composite PMI for June dipped below 50 last week (indicative of a contraction in output), while official Italian industrial production printed a 0.6%mom decline in May.
A combination of these factors caused the spread of the Italian 10-yr government bond to the German bund to widen by around 80bp between Friday July 8 and Monday July 11. While spreads have since come off those highs, they remain elevated (Chart 1) and on an asset-swapped basis (controlling for the FX regime), they are above early 1990s levels, when public finances were much more distressed.
Alphaville says "...we think the points made in question three and four are worth lingering over".