After 17 years as the prime mover in Italian politics (nine as prime minister), Silvio Berlusconi is done. After surviving 2,500+ court appearances (his count), 50 confidence votes (on public record), and a seemingly endless string of sex scandals, he became a former world leader on Saturday night, when he submitted his resignation to Italy’s President Giorgio Napolitano.
Ultimately, Berlusconi fell victim to his inability to reform the Italian economy and to Europe’s mounting debt crisis. Mario Monti, a former European Union commissioner, is expected to lead an emergency government in pushing through austerity and reform measures that will include budget cuts and labor market deregulations, among others. But did the fall of Silvio and the rise of Monti come too late? In the first day of trading after Berlusconi’s resignation, global markets are signaling only the most cautious kind of optimism.
Global bond markets helped bring Berlusconi’s reign to a close, and they remain guarded in the first day of the Monti government. For the uninitiated, a bond’s current interest rate or “yield” indicates the degree of risk associated with the bond, and is the price the borrower pays for getting to borrow the investor’s money. Yields vary inversely with bond prices, so when investors are cautious about holding a bond and lending money, they’ll offer less money for the bond and rates will rise. If rates rise high enough, the borrower can’t afford to keep borrowing and may default.
If Italy were to default, it would take the euro currency with it. Italy is the euro zone’s third largest economy; without Italy, there is no common currency, and no European bailout will be able to rescue the $2 trillion economy if it goes under.
Last week, Italian bond yields, which had been rising for months, surged past 7% — a level widely seen as unsustainable — as Berlusconi lost his parliamentary majority and his grip on power. The market signaled that Italy wouldn’t be able to afford its current debt load without new and more effective leadership.
Today, the market suggests that the Monti government may constitute that leadership, although the fight to restore credibility in Italy’s finances will be long. This morning, yields fell to 6.29%, after the government was able to sell more than $4 billion in short-term debt. This continues progress made last Friday, when markets determined that Berlusconi was actually prepared to quit.
Anyone who expected to see a big drop after Monti’s Sunday appointment and Saturday’s emergency reforms in parliament was disappointed, and bond traders’ reactions varied from tepid to guarded. A trader at Commerzbank, a German outfit with more than $11 billion in Italian debt, said of falling yields that, “You have a better political situation in Italy but at the end of the day it's still a tiny amount. Its hard to say this is a vote of confidence by the bond market.”
Another measure of Italy’s fiscal health seemed to capture the market’s outlook as dawn broke over the U.S. east coast: analysts often look to the difference in yields between Italy’s bonds and Germany’s, by far the EU’s healthiest economy. This difference is the premium that investors charge Italy to hold its debt rather than make a safer investment in the European core, and held essentially steady at 4.56%. Italy stands at the brink of disaster, but is no longer moving towards it.
No one is rushing to call Italy’s progress this morning a turning point for the wider European crisis. Even as Italian yields dipped, Spanish interest rates ticked up. Greece will still likely default without further loans and guarantees, even under the new Papademos-led unity government. France is starting to look unhealthy. Germany will soon have to decide whether to let the euro disintegrate or start writing checks, fat and many.
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