Blain’s Morning Porridge, 14th Oct 2020: La Dolce Vita?

“By 1965 there will be total depravity. How squalid everything will be…”

There are mornings when you wake up, look up to the skies, and go… oh no… “not again”.

But let’s be positive. There is so much good news out there..

Investors around the globe were no doubt be delighted at the opportunity presented yesterday to lend Italy 3-yr money for slightly less than zero yield.  The €3.75 bln Zero deal was 1.4 times oversubscribed. (If I were a cynic I might suggest the ECB will end up holding most of it under QE, after the Japanese investors who bought for a positive currency hedge dump it…)

But I am not a cynic this morning. I am keen and enthusiastic and looking for more reasons to be cheerful. So, if you are Sovereign Bond investor, you should have filled your proverbial boots – because next month Italy will probably be raising money even cheaper. The flattening curve means the prospect of a Zero-Coupon Italy Perp is just around the corner. Just 8 years ago, when we all confidently expected Italy to explode, default and exit the Euro, it was paying near 8% on debt, and trading by appointment only.

How wrong we all were about Italy.  Europe’s least competitive economy with the highest debt load (155% of GDP) commands premium pricing.. and all be because the ECB has enabled it. Why all the worry? All that Italy needs to do is grow its economy, and everything will be just fine. Simples. (Except… as any man will tell you.. “fine” is the most dangerous word in the world..)

Italy is doing well re numbers in the second Covid wave, but the economy has contracted 9% because of the pandemic, and isn’t actually expected to fully recover till some time in 2022. It won’t get back on its debt reducing budget surplus track till 2024 – or “never” as any date longer than 36 months is considered in the currently popular shorten-duration game of bond investment.

That should not concern us unduly.  Italy is an important and valued member of the EU, and now that the UK is about to be kicked into the long-grass by the French denying us a Brexit deal – Italy steps up a place.  (Rule 1 in the history of UK relations with Europe: it’s never the UK’s fault. If anyone suggests it is – blame France.. it’s probably them.)

The ECB’s Pandemic Emergency Purchase Programme (PEPP), and the soon to be released grants and loans from the Next Generation EU recovery fund will ensure Italy has zero funding costs for ever.. Therefore, what else can happen except an explosive outpouring of Italian entrepreneurship and growth.. because that is what 8 years of ultra-low European rates have achieved across Europe – haven’t they?

Oh… they haven’t… that was probably because rates weren’t low enough. Well they are zero now.. so what can possibly go wrong?

The answer to that question is long-term stagnation, deflation and decline – but because I don’t want to sound grumpy and suspicious.. I won’t say it.. (Some say Italy has been in historical decline since Atilla’s visit to Rome in 410, but that’s a tad harsh..)

What if the Pandemic and the response means Italian growth remains stifled by ongoing restrictions, Brexit tariffs (yep, we’re going skiing in Scotland!) and rather than a “swift” 2-year recovery, it takes longer? Much Longer.  What if tourism loses another season? What if businesses give up and throw themselves on welfare? The reality is Italy’s growth was already weak and insipid before the Pandemic.

Just like Covid has cut a swathe through the elderly and infirm it might do the same to sickly economies.

There are bank forecasts out there suggesting Italy’s Long Financial Covid could last for years, impacting growth and expectations through the 2020s, putting further pressure on the country’s fragile politics, raising populist threats and a potential North/South split. The economic effect would be similar to the way the great depression triggered by 1929 cause recession through the 1930s. Italy became a fascist state earlier in 1922 due to the weakness of the economy post WW1.

Today Italy’s economy is still suffering the negative effects of the 2008 banking crisis – which remains essentially unresolved – and the following European sovereign debt crisis – which is also essentially unresolved. Essentially (3 uses of the same word – deliberate) Italy is relying on policy made on the hoof.

Key Phrase I used earlier is that Italy is still solvent because the ECB has enabled it.

Italy is not a Sovereign Borrower. It is in exactly the same boat as any Latin American sovereign that borrowed in dollars. Since it joined the Euro, Italy has no fiscal agency and monetary authority. Italy can’t decide to create Euro’s through its own central bank to finance infrastructure, bank bailouts, or target fiscal stimulus packages.  The monetary rules of the ECB mean it needs the EU to nod at breached debt guidelines to put stimulus in place. It does not control the money printing presses. It might be easier if the EU was in a monetary union, but it’s not – and is unlikely to ever be.

The Euro is just a pooled currency under which members gave up financial sovereignty and agreed to stick to monetary rules – which Italy has not met. It benefits some – Germany – and penalises the rest.

When the ECB President Christine Lagarde misspoke and said it wasn’t her job to keep bond spreads tight, the market crashed! Italy yields soared. She soon corrected herself and has clearly learnt the lesson: that she is playing a very difficult and complex Game of Politics within the EU, trying to reconcile the unspoken promise to continue Mario Draghi’s Do-Whatever-it-Takes efforts to keep yields low, versus a rising tide of national self-interest across Europe – which is being accelerated by the pandemic effects on job security.

Italy is surely too big for other EU members to deny? Surely Germany would never ever insist Italy meets its debt targets? That would mean austerity and further economic decline…

Germany, Holland, Finland are all negative on unlimited support. The European election cycle means the costs of bailing out Italy will feature in Northern Europe. While Lagarde has distracted and deflected some of the criticism of the ECB by her pledges on Climate Change and support for diversity, especially women in finance, its still early days in her EU Presidency.

Meanwhile… An Apple a Day.. 

Apple announces a new phone that you simply must buy! This one is a slightly different shape! And it’s available in Blue. It’s completely, utterly and irrevocably future proofed for at least the next 12 months. It comes complete with 5G connectivity meaning it absolutely can do what other phones that were already 5G enabled do already. And, wait for it… it will do everything, yes absolutely everything your current iPhone already does.

Wow.. isn’t that fantastic? £1100 winging its way their way now!

I expect the stock will go through the roof. I can’t wait to buy one in November, or maybe I better pre-order now just in case there is a queue… and someone isn’t wearing a face mask…

Five Things too Read Today

FT – Europe’s far-right stumbles as infighting and rivals sap strength

FT – Hedge fund short sellers target pandemic winners

BBerg – Lagarde’s Mixed Report Card After One Year At ECB

WSJ – JP Morgan, Citigroup Signal Economy Not Out of the Woods

Torygraph – Negative interest rates have failed everywhere and are the path to Soviet banking

Out of time.. and back to the coal face…

Bill Blain

Shard Capital