As Italy’s 10-year interest rate hovers around 5 percent, flashbacks to late 2012 become inescapable. A time not far off when Italy’s place in the Eurozone was in question. Could we be on the brink of another debt crisis?
Many in the investment world have a myopic view, focusing intently on ‘the spread’, especially with nations deep in debt. As per the International Monetary Fund (IMF), Italy currently boasts a rather ‘admirable’ debt-to-GDP ratio of 144 percent - and this pertains only to public debt.
Debt is costly
However, the undeniable fact remains: this debt accrues interest. The significance of the spread becomes somewhat diluted when viewed in this light. For context, just a year ago, the spread stood at approximately 230 basis points, compared to a marginally improved 200 basis points today. Yet, Italian interest rates have surged by over a percentage point in the same period.
The European Central Bank (ECB) is staunch in its stance, advocating for sustained high interest rates, with an aim to combat persistent inflationary pressures. This brings the imminent ‘maturity wall’ into sharp focus. Sidestepping 2023, Italy faces the mammoth task of debt refinancing over the subsequent three years. Given the widespread surge in interest rates, whether one opts for short or long refinancing, the impending interest costs are set to skyrocket.
Drawing a parallel to late 2010 - just prior to the eruption of the European debt crisis - the current scenario appears even graver. Interest rates spanning up to 15-year maturities exceed those from 13 years ago. The shorter the debt tenure, the deeper the burn. To elucidate, Italian two-year interest rates currently exceed the end-2010 rates by over 100 basis points. Simply put, debt rollover is a painful affair. And for context, Italy’s debt-to-GDP ratio was a mere 119% in 2010.
ECB (always) to the rescue
Yet, the Italian bond market remains conspicuously unruffled. The rationale is straightforward: post the European debt crisis, the ECB has consistently cushioned nations against soaring interest rates. One would have to delve deep into a search engine to uncover the plethora of initiatives (with a myriad of acronyms) that have been introduced. With mechanisms such as the Transmission Protection Instrument (TPI) having such an ambiguous framework, Italy’s bond spread in a potential forthcoming crisis seems preordained.
Things That Make You Go Hmmm
It seems plausible that facilitating ‘debt sustainability’ has covertly become an ECB objective. The strategy remains consistent: reduce interest rates and engage in direct debt purchasing. Nonetheless, this relentless financial containment has profound ramifications across financial markets, impacting optimal portfolio allocations. This is a conversation for another day.
Jeroen Blokland is the founder of True Insights, a platform committed to independent research aimed at curating diversified multi-asset portfolios. Formerly at the helm of multi-assets at Robeco, Blokland’s ‘Chart of the Week’ is a much-anticipated feature every Monday on Investment Officer Luxembourg.