Why an Italian government bond sell-off is so worrying

ON BONDS

We believe financial markets are massively underestimating the scale of the problem in Italy and its associated downside risks. To understand why, we need to put Italy's bond market into context.

In 2001, global financial markets were violently shaken when Argentina defaulted on US$95bn of debt - the biggest sovereign default to date. In 2008, Lehman Brothers’ collapse sparked the most severe financial crisis since the Great Depression. Lehman Brothers had $613bn of liabilities. More recently, it has been Greece’s turn to wobble. Greek government debt levels are rising rapidly, and including its bailout loans, Greece has almost €350bn or US$480bn of debt outstanding. But Italy is a whole new ball game. Italy is the world’s third most indebted country with debts just shy of €2trn,...