David Stockman highlights how quantitative easing has broken down the standard price discovery dynamics in the sovereign bond markets.
The case of Italy is striking illustration. It has a clearly unsustainable sovereign debt of 133% ($2.4 trillion), the second largest in Europe after Greece. Its over-sized $4.4 trillion banking sector (double the GDP), with over $400 bn non performing loans, is technically insolvent. But the country's 10 year bond yields have been constantly declining. At 1.18%, it is lower than even comparable US Treasury Bond!
Stockman is spot on,
The notion that today’s yield of 1.15% on the Italian 10-year bond even remotely compensates for the risk embedded in Italy’s fiscal and economic chamber of horrors is just plain laughable. And that’s to say nothing of the risk the Brexit is just stage one, and that the EU itself will ultimately succumb to a wave of populist insurgency, including a Five Star led move to take Italy out of the euro. Indeed, Italy is truly a case of the blind leading the blind... Needless to say, these (government bonds) securities are vastly over-valued owing to the Draghi bond-buying spree, and they would plummet in price were the speculators who have been front-running Draghi’s QE campaign ever to loose confidence in the ECB or the ability and willingness of an Italian government to continue the giant fiscal charade now in place... with public debt already at 133% of GDP, why would anyone except Mario Draghi’s printing press be buying 10-year bonds at a 1.15% yield? Once upon a time, price discovery by the bond vigilantes kept governments quasi-sober and functionally solvent. No more. The Italian Job now underway is just the opening round in a world of failed states and broken markets.