Italian 10-year bond yields have reportedly risen to a new Euro-era record this morning. The latest quote they showed put the yield at 6.518%.
Thus it has crossed another trip-wire level: 6.50% and stock markets are freaking out. Why does anyone care, you ask?
One of the keys regarding this is the possible increase in margins which may be triggered. A report I came across a few days ago alerted me to the need to monitor the possible actions by the various clearing houses. For example, yield spreads above 4.50% (450 basis points) over the German Bunds rate prompted clearing houses to raise the margin required on Ireland and Portugal 10-year bonds that were used as collateral.
If Italian yields hold above 6.5% and if the spread remains greater than 450 bp then there could be some very unpleasant consequences. As reported in the piece I saw, LCH Clearnet considers 450 basis points over a basket of AAA countries a point at which extra fees may have to be charged.
The key here is that an increase in the margin requirements could be the catalyst for additional selling of Italian bonds on top of that already being caused by Merkel's and Sarkozy's actions. Remember, the “voluntary exchange” (which, of course was forced) that Team Merkozy enforced on Greek bondholders meant that the CDS hedges banks and investors had purchased as protection against default won’t pay off. And this, of course, has called into question the viability of CDS on Italian bonds. This brings us to the method investors now have to utilize in order to reduce their risk – selling the bonds.
Of course, additional selling would pressure the markets and could lead to even higher rates. This then can become a negatively self-reinforcing feedback loop. The European Central Bank could reasonably be expected to ignore the German Parliament's demand that the ECB stop buying sovereign debt and move aggressively to hold down rates. If that doesn't work then the negative feedback loop could gain momentum.
It was finding themselves in a similar situation that in the end caused Ireland and Portugal to ask for assistance. Italy has something like €30-€40 billion of debt it must refinance by year-end and another €300+ billion to roll-over in 2012. An elevated and climbing rate would be unsustainable in the opinion of most experts.
Remember, most analysts consider that Italy too big to bail (as in bail out, that is).
Have a good one...
Curtis Bergquist
Options Manager: Daily Decision-PRO
iShares Italy Last 12 Months
Remember, you are in control your email alerts! You can receive alerts for more than 25 free research report alerts including: The “10.0” Report, The Insiders Report, ETF Leaders Report, and The Focus List.
