Italian debt default could be worst ever shock to eurozone, Hedge funds build biggest bet against the country since 2008

Italy, one of the founding members of the European Union, is facing significant problems related to the payment of its public debt. In response, this month, international hedge funds have placed their biggest bets against bonds issued by the Italian state since the financial crisis of 2008.

Market speculators are now betting on a default by Rome, which would create a real shock in the eurozone.

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The total value of Italy’s bonds borrowed by investors to wager on a fall in prices hit its highest level since January 2008, at more than €39 (US$39) billion, according to S&P Global Market Intelligence data.

Financial analysts have been anticipating the problems the government in Rome will face since July with the European Central Bank’s announcement, the first in more than ten years, of an interest rate hike in the eurozone.

The rush by investors to wager against Italy comes as the country faces rising economic headwinds from the surge in European natural gas prices prompted by Russia’s supply cuts and a fraught political climate with elections looming in September.

“It’s the most exposed [country] in terms of what happens to gas prices, and the politics is challenging,” said Mark Dowding, chief investment officer at BlueBay Asset Management,  which runs about US$106 billion in assets to the Financial Times. He is shorting Italian 10-year bonds using derivatives known as futures.

DEPENDENCE ON RUSSIAN GAS

International analysts consider the main risk to the Italian economy to be total dependence on Russian gas and the ever-increasing threat that, amid political tensions in Europe, Moscow will turn off the tap.

The International Monetary Fund (IMF) warned as early as last month that a Russian gas embargo would lead to an economic contraction of more than 5 percent in Italy.

And the much-vaunted alternatives to Russian gas — the supply of liquefied gas (LNG) from the U.S. or natural gas from Angola and Algeria — are considered so insufficient, or even improbable, that they justify a massive speculative movement on the stock exchanges, worthy of the debt crisis of 2010- 2011.

ECB FUNDS ARE ALSO IN DOUBT

Investors also see Italy as among the countries most vulnerable to the European Central Bank’s decision to roll back its stimulus programs by raising interest rates and halting bond purchases that have financed Rome’s excessive debt.

The political situation in Italy is also not calming markets. The resignation of Mario Draghi as head of the Italian government in July 2022 led to the breakup of the national unity coalition and to a political crisis that amplified the already increased risks to the Italian economy.

Italy’s default or exit from the monetary union would have enormous consequences for the single European currency, which may face its biggest crisis since its creation.

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