Investors bet euro will continue slide to $0.9

Bloomberg

The European Central Bank’s (ECB) battle to restore its credibility with the financial markets just got a whole lot harder.
After a week marked by a fresh crisis in Rome, MLIV readers warn Italian debt risks hitting the danger zone once more — just as a near-imminent recession intensifies the epic plunge in the euro to levels not seen in almost 20 years.
Just 16% of 792 respondents in the latest Pulse survey say Europe will likely manage to dodge an economic downturn over the next six months, with 69% betting that the single currency will slide to $0.9 rather than claw back to $1.1.
To make matters worse, the political storm in the euro area’s third-largest economy may spur a new era of market fragmentation. Some 21% of MLIV readers say the spread between 10-year Italian and German bonds would have to blow out to more than 500 basis points — the highest since the 2012 debt crisis — before the ECB steps in.
All told, 41% of respondents, which include portfolio managers and retail traders, see a debt crisis within the next six months — a massive shift from the era of negative yields that engulfed the region as recently as early January.
These warnings couldn’t come at a worse time for the ECB. It looks poised to raise interest rates this week at long last — just as Russia threatens to escalate the
energy crisis with inflation
already at records.
“I think expectations of a recession have ramped up quite quickly on the possibility of gas rationing, and if that plays out, you could see a lot of companies go to the wall,” said Craig Inches, head of rates and cash at Royal London Asset Management.
Elevated price pressures have taken a big toll on households and companies. Now fears are rising over a full-scale halt in Russian gas shipments once maintenance on a major pipeline finishes around July 21. It’s the same day the ECB is seen raising rates for the first time in more than a decade, while potentially unveiling a novel policy tool to fix the growing cracks in the bond market.
The central bank was forced last month to pledge a new backstop after the yield on Italy’s 10-year debt rocketed above 4%. With Prime Minister Mario Draghi’s ruling coalition in tatters, the challenge for monetary officials is only getting harder.
“If the political situation turns hostile and Italy’s new government can’t agree a path forward with the European Commission, the ECB cannot realistically be expected to intervene,” according to Bloomberg Economics. “Given it will still have to tackle inflation, the result would be fragmentation — and potentially a crisis.”
ECB President Christine Lagarde has indicated that the backstop would be deployed if borrowing costs for weaker nations rise too far or too fast and would entail further bond purchases. Economists surveyed by Bloomberg expect the liquidity those purchases create to be reabsorbed in a process called sterilisation.
In reality the crisis tool is designed as a bluff — a signal that the monetary authority will do whatever it takes to backstop the single-currency bloc, resulting in a situation where it doesn’t actually need to purchase any bonds.
Nearly half of MLIV respondents see the ECB intervening once Italy’s yield premium over Germany reaches 450 basis points or more — way beyond the 250 basis point threshold cited by analysts earlier this year.
The good news is that 59% of respondents said they don’t expect a debt crisis in the euro zone in the next six months. And the majority sees a gas cut-off as the most likely catalyst should things go awry. Only 18% cited an underwhelming anti-fragmentation tool from the ECB as the proximate cause for any debt crisis.