Credit quality beats rate hikes
The Manila Times
if that situation does not change, my expectation is that it will be much more expensive for Italy to refinance its debt. That will be serious enough but the underlying development is much more worrying. Italy is becoming an exponent of the development among several countries in the eurozone that has been going on for years, namely a declining credit quality. This growing downside scenario is still in a quite distant future but many large bond investors are taking very long-term views of their portfolios. Therefore, strategicacting bond investors may very well start allocating away from a risk they see on the horizon and those they do not want to have at an early stage. Quite formally, many professional investors only require that either Standard & Poor’s or Moody’s give an “investment grade” assessment for the investor to consider the requirement for an “investment grade” rating as fulfilled. This only applies to those investors/funds that cannot invest in bonds with a lower credit rating than “investment grade” but there are quite a few that have the “investment grade” requirement. It will certainly take a number of years before Italy is considered “high yield” by all rating agencies but the financial market is not necessarily waiting for these kinds of formalities. This year alone, the interest rate on Italian government debt has risen noticeably, and the 10-year interest rate went even above 4.0 percent for a period in June. Italy’s national debt at 150 percent of GDP is just one of many elements that will fundamentally worry investors and undermine faith in the country’s credit quality. This summer, the country’s economy and labor market is favored by an enormous appetite for tourist trips among Europeans and Americans. But even under these circumstances, Italy has an unemployment rate that is significantly higher than in many other Western countries. As the flow of tourists decreases as the recession sets in both the USA and Europe, I judge the joy to be short-lived. I expect the US to come out of its recession fairly quickly but I am somewhat more skeptical about Southern Europe. Southern Europe is most likely to be stuck in a low-growth situation and that is where I expect long-term bond investors to seriously start considering Italy’s credit quality. I do not know whether a common EU solidarity tax for Italy can change the development. Right now, my primary scenario is that investors’ concern will grow at some point. The concern may spread to other Southern European countries as well as to corporate debt. Such a development should not be underestimated because one thing is a rising interest rate and that can be expensive. However, if the credit quality is seen as poor among investors, then it means that investors disappear and thus a country cannot refinance the debt anymore — that will hit much tougher than an interest rate increase. Peter Lundgreen is the founding CEO of Lundgreen’s Capital. He is a professional investment advisor with over 30 years of experience and a power entrepreneur in investment and finance. Lundgreen is an international columnist and speaker on topics about the global financial markets.