Wednesday, 29 August 2012

Italian Bond Rally Weakens Monti’s Hand With Merkel: Euro Credit

By Andrew Frye - Aug 29, 2012 1:16 PM GMT+0400

German Chancellor Angela Merkel walks with Italian Prime Minister Mario Monti following their 
meeting at Villa Madama, in Rome, on July 4, 2012.

Italian Prime Minister Mario Monti’s campaign for collective action to fight Europe’s debt crisis may be compromised by falling bond yields as he meets German Chancellor Angela Merkel.

Aug. 29 (Bloomberg) -- Piero Ghezzi, head of economics, emerging markets and currency research at Barclays, talks about the European Central Bank's bond-buying program and the outlook for the euro. He speaks with Mark Barton on Bloomberg Televsion's "On the Move." (Source: Bloomberg)
Italy’s credit is as good as it has been in three months, according to the nearly 1 percentage point decline in 10-year bond yields from 6.7 percent on July 25. That may make it easier for Merkel, who is hosting Monti in Berlin today, to sidestep the Italian premier’s proposal for the region’s rescue funds to buy bonds with the support of the European Central Bank.
“Monti’s arguments have more force when yields are spiking in spite of the fact that his government has implemented a number of credible reforms,” said Mujtaba Rahman, an analyst at Eurasia Group in New York. “It is at this moment when his argument carries more thrust with the Germans.”
Monti, 69, is on the road as European leaders prepare for the next phase of fighting a crisis that started with Greece three years ago and spread to Ireland, Portugal and Spain. Italy, which is due to sell $21 billion of debt in the next two days, still pays about 1 percentage point more to borrow for a decade than the average for the last five years. Monti said he may request the bond buying to bring down those funding costs, while seeking to limit any conditions the European Union would try to impose.
“Certainly I don’t want Italy, after all the efforts we have made which are producing results, to be subjected to some sort of intrusive special administration like has happened with the countries that needed aid to balance their accounts,” Monti said in an interview published in Il Sole 24-Ore today. “We are not in that situation.”

Pressure Easing

Italian 10-year yields rose 3 basis points to 5.86 percent today. Spanish yields of similar maturity debt gained 7 basis points to 6.55 percent, while the German rate fell was little changed at 1.34 percent.
The pressure on Monti has eased since July thanks to pledges of support for future EU bond-buying efforts from ECB President Mario Draghi, and the German government’s diminishing opposition to bond-market intervention by the central bank. Investors have made a total return, including reinvested interest, of 6.5 percent on Italian bonds since July 24.

Demand for Bonds

“There is demand for Italian paper, but still on the very short-term part of the curve,” said Nicola Marinelli, who oversees sovereign and high-yield debt in a $160 million fund at Glendevon King Asset Management in London. “There is still the risk that the demand for bonds can collapse if we get the wrong kind of news out of Italy.” Marinelli doesn’t own Italian or Spanish government debt.
The ECB may use its funds to lower yields if Italy and Spain request such aid, Draghi has said. The central banker is expected to give details of the bond-buying plan and possibly lay out what type of conditions the ECB would demand in return when the Governing Council meets on Sept. 6. Still, Bundesbank President Jens Weidmann this week reiterated his opposition to ECB bond buying, saying in an interview with Der Spiegel that it “can become addictive like a drug.”
“Preventing the ECB from buying government bonds to address imbalances, as the Bundesbank is trying to do, could end up, particularly in the case of German, becoming an own-goal with paradoxical effects,” Monti said in the Sole interview referring to a soccer play who accidentally puts the ball into his own net.

Debt Load

Bringing down funding costs is critical for Italy, which has a debt of almost 2 trillion euros ($2.5 trillion), the euro- region’s second biggest in nominal terms after Germany. The Treasury still has to finance 165 billion euros of maturing bonds and bills this year, more than three times the level faced by Spain.
Italy sold 3 billion euros of zero-coupon 2014 debt yesterday to yield 3.064 percent, down from 4.86 percent at the previous auction on July 26, as investors bid for 1.95 times the amount offered, compared with 1.78 times last month. The results were “relatively good,” Annalisa Piazza, fixed-income analyst at Newedge Group in London, wrote in a note to investors.
Today’s planned 9 billion-euro auction of six-month bills precedes the sale of as much as 7.5 billion euros of five and 10-year bonds tomorrow.

Threat to Euro

Monti was helped in negotiations with Merkel earlier this year when advances in Italian yields prompted speculation that the 17-country euro group could break up. Merkel was persuaded at a June 28-29 meeting of euro-area leaders to allow Monti’s push to grant the region’s bailout funds more flexibility in coming to the aid of nations like Spain and Italy, who are bringing down their deficits and still facing high financing costs.
Support for Merkel has been increasing in Germany as European leaders prepare for what the chancellor called a “decisive phase” in their crisis fighting efforts. Merkel’s Christian Democratic Union and its Bavarian sister party climbed three percentage points to 39 percent, the highest since July 2008 and since the incumbent coalition was formed, according to the weekly Forsa poll for Stern magazine and broadcaster RTL published today.
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