(Courtesy of The New York Times)
Investors drove up the cost of borrowing for Italy beyond 7 percent, a critical level that many economists see as unsustainable and that last year precipitated bailouts for the financially troubled nations of Greece, Ireland and Portugal.
“Wednesday’s surge in Italian government bond yields has catapulted the euro zone crisis into a dangerous new phase,” said John Higgins, a senior markets economist with Capital Economics, in a research note.
Italy’s problems come just weeks after European leaders thought they had stemmed the tide by agreeing on a debt restructuring for Greece and bolstering a bailout fund that was supposed to protect Italy.
But on Wednesday investors swept past those firebreaks, dumping Italian debt after one of Europe’s big bond-trading clearinghouses raised the collateral it requires because of the increased riskiness of the debt. Meanwhile, banks have been offloading Italian bonds to reduce their exposure, and investors took negative bets on Italy by selling bond futures.
In stock markets, investors unleashed a wave of selling across the board in Europe and the United States.
In Europe, the major indexes ended down around 2 percent. Wall Street opened sharply lower and never recovered, pushing the broader market deeper into negative territory for the year. The Standard & Poor’s 500-stock index ended down 3.7 percent, or 46.82 points, at 1,229.10.
As interest rates on Italian bonds peaked at about 7.48 percent, the European Central Bank intervened by buying the debt, traders said, causing rates to fall back slightly. But this latest phase of Europe’s financial crisis is putting a new focus on the central bank, with many expecting it to have to act more aggressively in buying Italian debt than it has so far.
The euro tumbled, and Spanish and French bond yields also rose amid fears that the contagion could spread further. However, some gauges of credit market stress did not worsen markedly on the day. And analysts said Italy is a stronger economy than other nations that have sought bailouts and has the strength to weather the current high interest rates at least in the near term.
Investors may also be reassured if in the coming weeks Italy, the third largest economy in the euro zone, can solve its political problems and put together a new government to tackle its slowing growth and budget pressures.
But investors Wednesday dumped Italian debt after one of Europe’s big clearinghouses, LCH.Clearnet, required increased margin for trades, making it more expensive for investors to buy and sell.
Banks have also been offloading Italian debt to reduce their exposure to Europe’s financial crisis, which has tended to put further upward pressure on interest rates. Since July, for example, BNP Paribas has reduced its exposure to Italian government debt by 40 percent to 12.2 billion euros.
Italy is also the only country among Europe’s weaker nations that offers investors the opportunity to buy or sell futures contracts tied to Italian bonds, and investors have been taking negative bets against Italy by selling futures, adding to the pressure.
In addition, many analysts say because the Greek debt write-down did not set off credit-default swaps that are supposed to serve as insurance on Italian bonds, investors concluded that the hedges they had in place did not offer sufficient protection, another reason for investors to sell debt and reduce their exposure.
Italy faces important tests of investor confidence at an auction on Thursday of one-year bills to raise 5 billion euros, and an auction next week of five-year bonds when it hopes to raise up to 3 billion euros. About 48 percent of Italian debt is held by Italian investors; the rest, 52 percent, is held by investors outside Italy, mostly in Europe.
It is unclear who beyond the central bank will be providing demand for Italian debt in the coming weeks.
Some fund managers in London said the sell-off in Italian bonds gained momentum after the clearinghouse raised margin calls on Italian bonds, including 30-year maturities.
“We’ve seen this before in terms of Greece, Ireland and Portugal,” said Sohail Malik, the lead portfolio manager of European Credit Management’s special situations fund. “Margins increase inevitably leading to deleveraging. Investors start selling and margins rise again. It’s a self-fulfilling prophecy.” He said that selling was met by a dearth of buyers, with the central bank appearing to only start aggressively buying Italian government debt around noon.
But Mr. Malik and others believe that the central bank will have to step up its buying of bonds if it wants to stabilize the country’s yields. “Right now, the E.C.B. are buying at a pace of 8 billion to 10 billion euros per week. Market sentiment indicates a need closer to 60 to 70 billion euros per month to stabilize Italian yields.”
He said Italian banks would try to provide strong demand at the auction on Thursday to try to make it a success.
The market shudders did not appear to set off quick policy reactions from European officials or, apart from bond buying by the European Central Bank, by central banks around the world including the Federal Reserve.
A spokesman for the International Monetary Fund said Wednesday that the fund currently had no plans to offer Italy financial assistance.
“It’s really up to Italy to act,” said one European official, who spoke on the condition of anonymity.
There is a feeling among several European leaders that all the central bank buying so far has only allowed Italy to stall its fiscal and political reforms, and perhaps the market pressure on Italy is needed to make its government react as it should, the officials said.
As painful as a Greek default would be, the world economy faces a much graver threat if investors abandon Italian debt and the cost of borrowing for the Italian government becomes prohibitive. Italy is the world’s fourth largest borrower, after the United States, Japan and Germany. It owes more than the other troubled countries on the periphery of Europe — Greece, Ireland, Portugal and Spain — put together.
On the Continent, French banks are the most exposed, holding more than $100 billion worth of sovereign Italian bonds. They are on the line for an additional $300 billion loans to private borrowers like Italian companies.
Investors fleeing euro zone risk poured into the perceived safety of United States and German government bonds, driving their prices up and their yields down. The yield on the German 10-year bond fell 8 basis points to 1.7 percent, while the equivalent United States Treasury fell 11 basis points to 1.968 percent. A basis point is one-hundredth of a percent