Why Hedge Funds are Betting 39 Billion Euros Against Italy’s Debt
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Why Hedge Funds are Betting 39 Billion Euros Against Italy’s Debt

Market data shows hedge funds taking a big position against Italy's growing national debt.
Neither the author, Kingsley Alo, nor this website, The Tokenist, provide financial advice. Please consult our website policy prior to making financial decisions.

According to recent reports, hedge funds have placed substantial bets against Italian government bonds due to growing worries over Rome’s political unrest and worsening economic situation. As per the S&P Global Market Intelligence data, over €39 billion has been borrowed by investors betting on falling prices. The total value wagered has surged to levels last seen during the global financial crisis in 2008

While Italy’s economy has been in dire straits, rising global headwinds and a fraught political climate have caused investors to rush in a wager against it. Rising inflation levels and the surge in the price of European natural gas following Russia’s supply cuts have had a severe impact. Also, upcoming elections scheduled in September after the abrupt resignation of the country’s former prime minister Mario Draghi have played a role.

Betting Against Italian Debt Highly Lucrative

Historically, betting against Italian debt has always been a highly lucrative investment for hedge funds. This is due to the country’s long-running political instability and concerns over its €2.3 trillion in outstanding government bonds.

In 2018, hedge funds profited massively from betting against Italy’s financial debt as wagers rose to their highest levels since the financial crisis. This was due to the market worrying about whether a coalition government would increase debt levels and loosen connections with the EU. However, hedge fund wagers have now surpassed 2018 levels in absolute terms and as a percentage of the overall bond issuance. This has given investors hope for where yields may go from here.

As a result of investor reaction to the growing unpredictability, Italian bonds have recently started to decline. Italy’s 10-year debt now has a yield of 3.7%, increasing the difference between theirs and Germany’s to 2.3 percentage points. The current value is up from 1.37 percentage points recorded at the beginning of 2022, as seen in the chart above.

Consequently, investors believe Italy to be one of the nations most vulnerable to the European Central Bank’s (ECB) plan to dismantle its stimulus programs. The financial regulator has recently started raising interest rates and stopped bond purchases supporting the country’s enormous debt market.

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Italy’s Economic Growing Crisis

The current economic crisis in Italy threatens the fate of the entire European Union. The situation combines excessive debt, poor demographics, and political instability, similar to the 2012 Eurozone crisis centered around Greece.

Firstly, Italy is one of the most indebted nations in Europe, with its public and private debt surpassing 330% of its gross domestic product (GDP). From various research, economic development begins to slow, and the standard of living drops when the total debt to GDP exceeds 300%. This situation is playing out in Italy at the moment.

From having a vibrant economy in the ’70s and ’80s, the country reached the point of excessive debt in 2010. Italy is clearly in a depression, as it has consistently recorded negative growth over the past ten years with no indications that growth will resume soon.

Secondly, aside from its debt, Italy has been thrown into a political crisis since Prime Minister Mario Draghi offered his resignation on July 14, 2022. The interim president of Italy denied Draghi’s initial resignation request. After the Italian Senate’s unsuccessful no-confidence vote a week later, Draghi again announced his resignation. While new elections are scheduled for September, Italy is virtually operating without a clear leader in place until then.

Italy’s Population Dilemma

Both problems mentioned above are symptoms of the lack of a working-class age group in Italy. People between the ages of 15 to 64 are necessary for an economy. They actively work, consume more goods and services, spend more money, and generate income that can be taxed to pay for a country’s debts. Unfortunately, Italy has a declining population within this age bracket.

With Italy’s population growth in the prime age group changed from positive to negative, its economy simply cannot function. In two or three years, future projections forecast that the European nation would overtake Japan as the country with the worst demographics in the developed world.

Consequently, to help Italy, the ECB has crafted a new policy tool, “Transmission Protection Instrument,” to purchase Italian bonds when they start falling apart. This is expected to prevent an inevitable debt crisis with far more repercussions across Europe. At the same time, the ECB has raised interest rates. This has now caused a bizarre situation where it is becoming hawkish while selectively being dovish for specific sovereign bonds.

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Do you think the ECB will prevent Italy’s debt problems from causing a full-scale crisis across Europe with its policies? Let us know your thoughts in the comments below.