Lack of Italy debt contagion explodes notion of euro
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[October 18, 2018]
By Abhinav Ramnarayan and Ritvik Carvalho
LONDON (Reuters) - The striking lack of
financial contagion across the euro zone from Italy's bond-market
blowout this year shows investors are breaking an eight-year habit of
lumping together the bonds of Italy, Spain and Portugal.
In an apparent vindication of European Central Bank efforts to reduce
spillover across the bloc each time one of the southern European
economies gets into trouble, the market has so far treated the Italian
budget dispute as a domestic storm.
For years after the 2010-2012 euro zone debt crisis, Italy, Spain and
Portugal - collectively referred to as the "periphery" by bond investors
- saw their bonds track each other.
Anything that risked a repeat of the euro zone's existential angst six
years ago tarred all the weaker credits with the same brush.
(Spain, Portugal stay strong during latest Italy selloff:
Yet six years after ECB chief Mario Draghi pledged to do "whatever it
takes" to save the euro zone, the correlation is fading.
An uproar over Italy's budget deficit and risks of a clash between Rome
and European Union authorities have barely touched Portuguese and
Spanish debt. Such has been the divergence that the premium demanded by
investors to hold Italian risk over Spain's hit its widest in over 20
"We are very close to record low levels in terms of correlation between
peripheral countries, and it's very clear that from the market
perspective for the first time in a while a major euro zone bond market
incident is not being seen as a threat to the euro system," said
Frederik Ducrozet, a global strategist at Pictet Wealth Management.
One reason is that the budget concerns are so far confined to Italy. But
idiosyncratic risks have in the past spread across southern European
bond markets too -- one example being the approach to the Catalan
independence referendum last year.
Confidence is higher this time that the Italian debt problem will not
threaten the country's euro membership. The country's anti-establishment
coalition government has been at pains to stress it has no interest in
exiting the zone.
Contagion would return only if the euro's future is in danger, said
Arnaud-Guilhem Lamy, a portfolio manager at BNP Paribas Asset
Iain Stealey, a fixed income portfolio manager at JPMorgan Asset
Management, said the fund he oversees has been buying Spanish government
debt through the recent Italian ruckus.
"If you're a fund manager and you don't want to own Italy, Spain and
Portugal are the only realistic alternatives," he told Reuters.
"Spain has been the poster child for European growth in recent years -
if you think about 2012, where unemployment rates were, how strong
concerns were over the banking system in the periphery, we are in a very
different place now," he said.
[to top of second column]
A woman gets money at an ATM machine in Milan November 8, 2011.
Italy has the third biggest economy in the euro zone and its debt
worries are a huge threat in the wider crisis facing the continent's
single currency. REUTERS/Alessandro Garofalo
(Spain, Italy bond yield correlation dips since May selloff: https://tmsnrt.rs/2J3cRxC)
Spain has led the euro zone economic recovery in 2016 and 2017, growing more
than 3 percent a year and earning multiple credit ratings upgrades to Baa1 from
Moody's and A- from both S&P Global and Fitch.
Portugal, not long ago rated junk by all three major agencies, last week was
restored to full investment-grade status after a Moody's upgrade. Its economy
grew 2.7 percent in 2017, outperforming the euro zone.
Both countries have benefited from their share of the ECB's 2.6 trillion-euro
($3 trillion) stimulus program.
But even countries partly or fully outside the ECB program have felt its effect.
Cyprus recorded stellar growth of 3.9 percent last year and Greece exited its
bailout program in August.
This week, Greece said it achieved a primary budget surplus well above target
for the year so far.
(Italy-Spain spread hits widest in 20 years:https://tmsnrt.rs/2Oqh0Sa )
"The type of investors invested in Spain and Portugal is not the same as it was
before," said BBVA rates trading strategist Jaime Costero Denche. "We have seen
new investors such as Scandinavian accounts and Middle East and Asian investors
who didn't want to buy peripheral debt in the past."
A major factor limiting contagion from Italy is that Portuguese and Spanish
banks are in better shape, thanks to authorities' success in tackling bad loans
-- a road Italy embarked on only recently.
Portuguese banks have mostly returned to profit. In June, Moody's lifted its
outlook for Spain's banking system to positive. It cited robust economic growth
and improved asset quality after disposals of troubled assets.
(Bad loans falling in periphery:https://tmsnrt.rs/2OpAWVf )
(Reporting by Abhinav Ramnarayan, aditional reporting by Dhara Ranasinghe,
graphics by Ritvik Carvalho, editing by Larry King)
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