Tuesday, August 14, 2012

Italy's GDP Falls 2.5% Y/Y; 10-year Italian, German Yields and Spreads ($EWI Trends, 8/13/12)

First off, Italy's recession worsened in the second quarter of 2012, with GDP down 2.5% year over year. And Italy's industrial production fell 8.2% y/y in June. Here is more info from the Italian National Institute of Statistics on Twitter (@Istat).





View a live chart comparing the the y/y percent change in Italian real GDP and industrial production since 2001 at Thomson Reuters Datastream, courtesy of Reuters' Scott Barber on Twitter.

Italy's economy was negatively affected by the 20 billion euros of austerity measures enacted by government at the end of 2011. To cut the country's budget deficit, the Italian government decided to cut spending and new jobs, and raise taxes and the retirement age, which ended up hitting consumer income, spending, economic growth, and other tax collections as a result. Read this Bloomberg article from June 12: Italy Tax Increases Backfire As Monti Tightens Belts.


Here is more from Reuters on Italy's GDP and industrial production report:

"This will weaken tax revenues and hit jobs and consumer spending, a vicious circle which makes it harder for Monti, who is aiming to cut the budget deficit to 0.1 percent of GDP in 2014, to meet his public finance goals."

Last year Italy's 10-year government bond yield and spread to German bunds (Germany is a safer credit) started to break out when Italy's sovereign debt and banks were downgraded by Moody's (June 24July 10Nov 1). And clearly the market was losing confidence in euro area sovereign debt, which was being affected by a solvency crisis and slowing economic growth. But after the European Central Bank provided a trillion euros to European banks in three year LTROs (longer-term refinancing operations) to prevent bank runs, Italy's 10-year bond yield fell and its yield spread to German bunds tightened. The market was also pricing in a positive result from the Greek default/bailout/debt exchange on March 9, 2012.

However, after these events occurred, Italian yields and spreads to German bunds moved back up again. Read this article at CNBC/Reuters this morning: Italy Public Debt Hits Record, Bailout Looms.

"Italy's public debt hit an all-time high in June of almost 2 trillion euros and the annual budget deficit was also bigger than a year before, due largely to Italy's share of bailouts for other euro zone states, the central bank said on Monday."

German bund yields continued to move down even when large hedge funds like Paulson & Co publicly said they took the other side (yields move inversely with prices). German 2-year government bond yields even went negative (1, 2)! Kind of off topic here, but a Bloomberg article on April 17 mentioned that Paulson & Co. was long German sovereign credit default swaps in late April. I guess if Paulson bought German CDS in early March at 75 basis points and sold at 102 bps in June, it would have been a decent trade. But FT said they started buying a few months before the release, which could have been a lot higher. And when German bund yields kept moving lower, German CDS fell all the way back to the April low. Germany's 5Y CDS premium will be interesting to watch though going forward.

It's interesting that the Italian 10-year yield made lower highs while the 10-year Italian-German yield spread tested the 2011 highs. This could mean that German government bonds are overextended to the upside. You have to time everything though, which technical analysis can assist with. 10-year German bunds currently yield 1.40%. It all depends if the German Constitutional Court agrees to contribute to the bailout fund and sacrifice Germany's credit status, which could ultimately hurt their bonds. They vote on September 12. Inflation in Germany could also affect its bonds as well. Other news at the Financial Times, Bloomberg Businessweek, and Zero Hedge: German lawsuit challenges rescue fundGerman 10-Year Bunds Drop on Greek GDP as Italy Sells Bills; New Lawsuit Filed Against ESM Threatens Further Bailout Fund Delay.


Italian-German 10-year yield spread via Bloomberg.com (at 4.50 next day) *interactive chart is down.



Italian 10-year government bond yield via Bloomberg.com



German 10-year government bond yield via Bloomberg.com (3 year chart)




$EWI, the MSCI Italy Index Fund ETF, started to price in the possibility of a recession in May 2011 when it peaked at $20. It then lost more than 50% and pierced through the March 2009 low ($9.53) when it bottomed at $9.21 on July 17, 2012. Since then, it bounced back to $11.21. But look at the chart, EWI IS STILL DOWN 69.3% from the May 2007 high of $36.51. Large-cap Italian stocks have more work to do technically before they can attempt to ride a new secular bull market. $EWI needs to break out of that steep falling wedge in that descending channel, break above June 2010 resistance, and take out that downtrend line from 2007. If EWI retests the lows again, there's always a risk it could break down.

EWI (iShares Italy Index Fund) via FreeStockCharts.com




Large distressed sovereigns in the euro area (Spain and Italy) are trying to balance out the negative economic effects of austerity to prevent their sovereign debt from collapsing, which could cause them to default and possibly leave the euro. They can't print money like the U.S., UK, or Japan to backstop their sovereign debt market, which would devalue their currency as a result (default risk exchanged for inflation risk). So they are relying on external sources of funding from the ECB, IMF, and large safe sovereign credits in the E.U. like France and Germany, to backstop their debt with deficit reduction targets attached. At Bloomberg.com: Greek Recession Making Bailout Targets Harder To Meet: Economy.

Spain's unemployment rate hit 24.6% at the end of the second quarter, and youth unemployment hit 53%. And France is headed for a recession? Here are more articles to read.

Spain, Italy Ratings Cut At DBRS As Debt Crisis Intensifies (Bloomberg)
France headed for recession: central bank (Reuters)
Europe Stocks Slip on GDP Fears - Capital Economics on French, German GDP - (WSJ)

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