Italy’s $2.6 Trillion Debt Giving Spanish Bonds the Edge

By Lukanyo Mnyanda and Eshe Nelson

Photographer: Alessia Pierdomenico/Bloomberg

An indoor market in Rome, Italy.

Italy is paying the price for having the euro area’s third-largest debt load with the rate investors charge to lend it money at the highest in more than two years relative to Spain.
While a selloff in euro-area bonds last week rekindled memories of the sovereign-debt crisis, the pain was being felt more keenly in Rome than Madrid. Traders judged that Italy’s bigger debt burden made it more vulnerable in a potential recession as the region’s economy falters.
Exaggerating the difference is Spain’s outlook. Since emerging from a six-year slump, it has become one of the fastest-growing economies in the euro
currency bloc. Italy is mired in a contraction; this month it cut its growth forecast while Spain’s Cabinet in September approved a budget based on higher growth estimates.
“The Italian debt dynamics are poor and would get worse remarkably quickly” if the euro area slides into a recession, said Andrew Milligan, head of global strategy at Standard Life Investments Ltd., which manages about $315 billion in assets. “People are giving Spain the benefit of the doubt because the economy is starting to grow.”

Economic Malaise

The extra yield investors get for holding Italian 10-year bonds instead of Spanish debt with a similar maturity jumped to 36 basis points, or 0.36 percentage point, last week, the most since February 2012. In July that year, with the euro area at the brink of collapse, Italian debt paid 116 basis points less.

Photographer: Angel Navarrete/Bloomberg

Spain’s economy will expand 1.3 percent this year and 2 percent in 2015, more than... Read More

Bonds from the euro area’s peripheral nations plunged last week and those from countries with higher credit ratings rose as investors sought the safest securities amid signs an economic malaise is spreading to Germany, the region’s biggest economy and engine for growth.
The spark for the latest selloff was renewed concern Greece will struggle to finance itself. Yields on Italian 10-year bonds jumped 17 basis points in the week to 2.50 percent, while those on similar-maturity Spanish securities rose 10 basis points to 2.17 percent.
Periphery government securities pared losses yesterday as the European Central Bank was said to have bought Italian covered bonds under an asset-purchase program introduced this year to reinvigorate the stalling economy.

Slowing Growth

Standard Life has overweight positions in euro-area bonds, both in the periphery and the core, because slowing growth, disinflation and ECB support mean that “if you do want to hold a bond market, then it’s better to have a mixture of European bonds in your portfolio,” Milligan said in a telephone interview from Edinburgh.
An overweight position is one in which an investor holds a bigger percentage of a security than is contained in the indexes used to monitor performance.
Italy’s 10-year yield was 30 basis points higher than Spain’s today. In October 2013 investors demanded 10 basis points less to hold the Italian securities.
A year ago, Italy “didn’t need to do that much to get their budget in good shape, the deficit was not really that big and at the same time, Spain had a lot of work to do and was experiencing very poor growth dynamics” said Robert Tipp, chief investment strategist at Prudential Financial Inc.’s fixed-income division in Newark, New Jersey. It oversees $533 billion in bonds. “Right now it looks like things are going a little better for Spain than for Italy.”

Government Debt

The recent selloff pared an advance that has seen Italian bonds return 11 percent this year through yesterday, headed for a third-year of gains, according to Bloomberg World Bond Indexes. The securities have been supported with other periphery bonds amid prospects of further European Central Bank stimulus and a government deficit that is within the European Union’s 3 percent rule. While the latest budget anticipates the deficit going up to 2.9 percent next year from 2.2 percent, that will be lower than Spain’s expected shortfall of 4.2 percent.
Italy’s 10-year yield is still almost 5 percentage points less than it was at the height of the sovereign debt crisis, when it jumped to as high as 7.48 percent. It reached a record-low 2.53 percent on Sept. 5.

Spanish Debt

Spain’s debt as a percentage of gross domestic product was at 92 percent in 2013, according to data released yesterday by Eurostat, the EU’s statistics office in Luxembourg. While that is more than the 60 percent posted in 2010, it’s less than the 128 percent ratio Italy had at the end of last year, which was up from 115 percent in 2010 and exceeded only by Greece and Portugal.
Italy’s total government debt was 2.07 trillion euros ($2.6 trillion).
Slower growth leads to a deterioration of government finances as tax receipts typically fall while expenditure on welfare programs including support for the unemployed increases.
Italian Prime Minister Matteo Renzi’s administration revised its economic forecasts for this year and 2015 to a 0.3 percent contraction and 0.6 percent expansion, respectively, compared with previous estimates of 0.8 percent and 1.3 percent growth.
Spain’s economy will expand 1.3 percent this year and 2 percent in 2015, more than previous estimates, Economy Minister Luis de Guindos said on Sept. 26.
Spain will outperform the euro area in each of the three years through 2016 while Italy’s economy will underperform by between 0.5 percent and 1 percent, according to Bloomberg surveys of economists.
“We prefer Spain more than Italy in the current environment since Spain looks to be more successful in implementing reforms,” said Daniel Lenz, lead market strategist for the euro area at DZ Bank AG in Frankfurt. “The spread between those has widened but I would say it’s not the case that this trend of spread widening must have already come to an end. We have not seen the peak yet.”