Sovereign debt worries on both sides of the Atlantic linked global markets in the throes of risk aversion Monday, sending money fleeing from equities and commodities and into the usual safe havens.
The glare of the investing community abruptly locked onto Italy’s monumental debt load with rising concern that contagion could fell the eurozone’s third-largest economy.
The fear of Greek default, considered an inevitability by many economists, also heightened Monday with European officials agreeing to involve the country’s private-sector creditors in a second bailout package, an arrangement that ratings agencies warn would technically constitute default.
The announcement came after eight hours of talks between the eurozone’s finance ministers on how to control the debt crisis.
“There will be a private-sector involvement,” said Eurogroup president Jean-Claude Juncker. “This is a decision that has been taken by the European Council. Talks will go on in the coming days.”
In the United States, meanwhile, the ongoing debt ceiling impasse stoked fears of a credit event in early August, an outcome thought both unlikely and catastrophic.
Any of which could provide the catalyst for a major economic slide.
“You don’t know which banks are greatly exposed to the debt problem, and you could get into the kind of credit freeze that was such a problem after Lehman’s bankruptcy,” said Sal Guatieri, senior economist at BMO Capital Markets.
Fresh off a brutal sell-off last week now dubbed “Black Friday” by Italian media, the country’s stock and bond markets continue to get drawn into the region’s sovereign debt crisis.
Yields on Italian bonds rose to 5.57% Monday, the highest level in more than a decade, opening up a spread of almost three percentage points above the equivalent German asset.
The country’s vulnerability is found in its ¤1.6-trillion pile of sovereign debt, a level of borrowing exceeded only by Japan and the United States.
Italy’s debt amounts to 120% of its GDP and dwarfs the combined borrowing of all the other countries already engulfed by the crisis.
“Greece, Ireland and Portugal, you can make the case that it’s a containable problem,” said Alex Bellefleur, a financial economist at Brockhouse Cooper. “The Italian economy is very large, the Italian debt market is enormous and it’s probably too big to bail out.”
A big chunk of Italy’s debt — about ¤200-billion — is held by the country’s banks, amplifying the internal risk of an Italian credit event.
“The correlation between sovereign and bank credit default swaps is explosive,” Lorenzo Bini Smaghi, a policymaker at the European Central Bank, said at a conference Monday.
At the same time, he dismissed the notion of an Italian default. “Italy will never default, it is a rich country that is clearly able to pay back its debts,” Mr. Smaghi said.
That same certainty was once offered with regards to Greece’s finances. But some version of Greek default is reportedly being discussed as part of a second bailout package.
“Greece in my opinion is insolvent and needs to default, and we’re moving towards that realization in the market,” Mr. Bellefleur said.
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