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The most indebted countries in Europe are not ready for the reality of the market

(Bloomberg) – The improving economic outlook in Europe with the resumption of Covid-19 vaccinations is also accelerating the timeline towards a new danger, as investors prepare for growth, they are also preparing for the consequence inevitable: the withdrawal of European Central Emergency financing from the Bank. For the region’s most indebted economies – including Italy which has always stood out – this would bring them face to face with market forces they cannot handle. Citigroup Inc. is bracing for a drop in bond buying as early as June, and M&G Investments says it’s time to start shorting peripheral debt, due to the ECB’s dramatic measures over the past year , borrowing costs in the euro zone have never been. disconnected from risk. Much of the region is emerging from the back of the worst recession since at least World War II, deficits have skyrocketed and debt is at mind-blowing levels, yet an investor lending money to Italy for 10 years cannot expect to receive an interest rate of around 0.75%. Greek bonds, considered an unwanted asset by the three major rating agencies, have a rate of less than 1%. Ten years ago, the debt crisis in the eurozone pushed yields above 40%. “You only get temporary elimination of credit risk from European sovereigns in an emergency,” said Eric Lonergan, fund manager at M&G. “The problem is, when you come out of an emergency you’re back to market forces in your bond market and some of those numbers look really, really bad. Europe is ironically vulnerable to the recovery. The eurozone debt pickup is mostly driven by the ECB’s pandemic € 1.85 trillion ($ 2.2 trillion) bond purchase program, and it helped fuel pockets investors. In the past year alone, Italian bonds have achieved returns of more than 10%, according to the Bloomberg Barclays indices. In ten years, they would have almost doubled their money. “The country is able to refinance its debt at much lower yields thanks to the ECB, so the crisis has been somewhat of a blessing in disguise for Italy,” said Hendrik Tuch, head of NL fixed income at Aegon Asset. Management. “The low yields and spreads of Italian sovereign bonds are not realized in Rome but in Brussels and Frankfurt, which is the main problem for the longer-term outlook for Italian sovereign bonds.” While ECB President Christine Lagarde said this week that it would be “premature” to talk about easing support, the debate on what to do and when could quickly approach. Some policymakers are poised to argue at the June meeting that the pandemic emergency procurement program is expected to start scaling back in the third quarter, Bloomberg reported on Friday, citing officials familiar with internal deliberations. Read more: ECB officials expect rocky June decision on crisis program Lagarde says ECB is not discussing phase-out of stimulus Bloomberg Economics: Lagarde optimism suggests less PEPP Purchases After 2Q Despite Lagarde’s reassuring words, such a speech will bolster investor attention on Judgment Day. Without emergency aid, the focus will shift back to debt in Greece, Italy and Spain, which increased further in 2020 due to needed health and crisis spending, and whether it can ever be brought under control. , head of global bonds, Robert Tipp, has maintained his lean towards peripheral bonds since the sovereign debt crisis, but is also starting to worry about the post-collapse outlook. the environment will return to fiscal rectitude, ”he said. “The fundamentals are lousy for some of these countries.” For now, European Union member states are preparing to spend money from the EU’s stimulus fund, which is expected to start disbursing cash around mid-year. Italian Prime Minister Mario Draghi, the former ECB president, credited with saving the euro during the latest debt crisis, is planning to reorganize the Italian economy with more than € 200 billion in funds. generate sustained growth strong enough to significantly reduce Italy’s huge debt, which currently accounts for around 160% of economic output. Fitch Ratings warned this month that Greece’s debt-to-GDP ratio will remain above 200% this year and any failure to reduce it could result in negative rating action. suspended during the pandemic – and what form they will take. While some countries’ fiscal positions have to be tackled, overly strict targets, for example on deficits, could do more harm than good by sucking the life out of economies. Saxo Bank A / S is one of the biggest evildoers on the European periphery, warning that there could be a part 2 sovereign debt crisis, starting with an exodus of foreign investors from Greek debt, where they hold 90%. Saxo’s concern is that with U.S. bond yields 60 basis points higher than at the start of the year – and with the currency hedging equation increasingly favorable – investors would prefer to invest in them. money rather than higher yielding European sovereign bonds. The unwinding dilemma will see her once again grappling with the challenge inherent in the euro zone: defining a monetary policy for 19 countries with very different economic, inflation, unemployment and debt situations. If it starts to tighten, the peripheral countries will be the ones to lose, making their huge deficits more difficult to finance. “It’s very difficult to see anything other than fiscal austerity,” said Lonergan of M&G. “I don’t know when it’s going to hit, but I think you get a very, very good chance if you look at a lot of the more vulnerable parts of the European bond market now.” For more articles like this, please visit us Subscribe now to stay ahead with the most trusted source of business news. © 2021 Bloomberg LP

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