The latest hike in how much it costs banks to raise funds using Italian bonds as collateral may be the last straw on the back of Italian lenders, pushing them to the point where they become dependent on loans from the European Central Bank. If Italy fails to pursue reforms that boost growth and cut debt and eurozone policymakers don't take measures that win Italy time to implement them, bond yields are likely to rise further prompting another increase in repo margins.
That will again lead to a rise in bond yields and result in a spiral similar to what happened in Greece and Ireland, countries whose banks are now dependent on ECB support via its unlimited euro liquidity tenders. It may not be long before the snowball starts to roll. Two clearing houses hiked margin requirements for repo operations using Italian bonds by 5 points on Wednesday, less than their initial 15 points increase in Portuguese margins, for example.
The increase in Portugal's margins came after five trading days in which yield spreads over an average of triple-A rated bonds traded above 450 basis points. Italy's spreads only traded above that level on Wednesday, according to Christoph Rieger, a rate strategist at Commerzbank. This should increase the Italian banks' loans from the ECB by 10-20 billion euros a month, from October's 111 billion, according to J.P. Morgan's Panigirtzoglou, but the risk is that the amount would rise faster if Italy is gradually pushed to ask for financial aid.
The spread between the three-month dollar Libor and overnight index swaps - a widely used gauge of money market stress edged up to a fresh 2-1/2 year high of 35.6 bps from Wednesday's 34.8 bps. The three-month euro/dollar cross currency basis swap also edged 5 bps wider to minus 117 bps, matching its widest level in almost three years hit on November 3, just before the ECB rate cut. The five-year equivalent hit its widest since early 2009 at -47.5 bps, versus -45.4 bps on Wednesday.