June 05, 2012

Bridgewater reminds us about Italy

It seems that the markets were focused on Spain debt/bank and other issues as of late but forgot about Italy. The media was also focused with tons of articles about Spain while Italy was ignored. According to Bridgewater, Italy will again gain in the competition for the media attention.

It seems that that the main rationale behind the lacking punishment of the Italian debt situation was the LTRO and the thought on mind that the free cash free credits will buy enough Italian bonds to safe the country from a spiraling debt crisis. Bridgewater shows us with one chart that this is wrong and the banks have no free money left to buy bonds neither to buy in the primary nor in the secondary Italian bond market.

We bold their "assumption" because as Bridgewater calculates, the 'dry powder' number is far, far less than conventional wisdom had been expecting. In fact, currently for Italy it is at negative €48 billion in residual LTRO capital. If that is right, and we believe so, Italy will have no way to plug its debt funding needs anymore which means that rates will start rising once again and more turmoil is expected. Now the question left is only whether the ECB will initiate a new LTRO operation or not. It seems quite unlikely to do as now is obvious the previous was failure and was a way to fund deficits through money printing. Also the ECB balance sheet is huge now and the leverage is super-high. We should not forget that the ECB’s Greek bonds values are also under risk which means that very soon not the Italian banks will need emergency cash but the ECB to be recapitalized.

Ray Dalio is an American businessman and founder of Bridgewater Associates. Bridgewater Associates has since attracted many clients including pension funds and is currently (as of January 2012) the largest hedge fund in the world with nearly $120 billion under management.