The average global investor pays no attention to Italy . Perhaps they should.

The average global investor pays no attention to #italy . Perhaps they should. Italy has the world’s third largest #sovereigndebt and its default may be the most veritable “grey swan” ahead.

For over a decade Italy has been unable to meaningfully reduce debt either through growth or fiscal tightening. In fact debt has massively increased even in the face of the most benign #ecb leadership imaginable (see chart). Since Draghi’s “Whatever it takes”, the ECB has been the only marginal buyer for Italian debt and it is now holding € 900 bil of it, approximately 32% of the total. Should the ECB stop or slow down purchases, Italy’s borrowing costs would rapidly skyrocket to unsustainable levels. Yet, with double digit inflation becoming anchored, the ECB needs to tighten and it is hard to see how they may be able to continue purchasing € 250-350 bil of Italian debt every year.

Adding fuel to the fire, a confrontation between the EZ institutions and the new Italian government appears inevitable on at least two counts. First off Italy is falling very short of the critical reforms that were at the heart of the 2020’s Recovery Fund initiative. Something that some EZ partners are likely to see as yet another broken promise. The other upcoming issue will be the need to further expand the budget deficit for 2023. It is obvious that the agreed 4.5% will not suffice and more debt will be needed as the economy is heading into stagnation/recession and families and companies alike have grown addicted to government subsidies. Just to give an idea, since Aug 2021 € 100+ bil of debt were quite litteraly “burnt” into energy subsidies only. Hence over the next few months Meloni’s government will relitigate yet more debt creation at a time when the ECB actually needs to reduce, rather than expand, its balance sheet.

To cut a long story short, the current situation in the EZ is simply not sustainable and something is going to have to give. Germany has been so far the key actor in ensuring the stability of the existing framework but may not be willing/able to play the same role in the future. The Ukraine/energy crisis has configured a true existential threat to Germany’s economic model. The country will need to muster all their focus and economic effort to restructure and adjust to a deglobalized world. They may decide that it may be more efficient and effective to go “solo” rather than trying to keep together a menagerie of 18 countries with very different histories and needs.

An EZ restructuring/fragmentation seems to be on nobody’s radar for 2023 but with a € 20+ trillion bond market perhaps it should.

​Disclosure: Not investment advice. Do your own research. Hold all assets mentioned. Twitter @pietroventani for more timely comments and updates.