Rumblings in the distance. Italy the next target?

Sovereign credit has been very much in the spotlight, be it Greece or the others.
Could Italy be the next to be caught in the crossfire?
The longer term argument for sovereign bonds remains the delicate balance between deflationary and inflationary pressures on the one hand, and the tug of war between large supply coming and possible increase in domestic demand as baby boomers, among other investors disappointed by equity, shift to income and buy government bonds.

We have been bearish on UK gilts for a long time, flattish on US treasuries, and warned not to be short german bunds. At the moment even the bunds could be at risk though, at least for a short while.

The concern we are divining from the rumblings and the gossips comes from the focus on the swaps that were used by Greece to hide its real public debt. From there it is a small step is now to move onto looking at all the swaps that Italy did in the 90's with similar aims.

Up to now Italy has been considered relatively safe from a sovereign point of view: the deficit is not too bad (though the overall debt is). The spread between its bonds and the German ones is comparable, or even lower, than the UK one.
If concerns arise on the veracity of public accounts, including local authorities, it won't be pretty.
Even if there is no substance to those concerns, even if the current numbers are reliable, it won't be pretty.

The chance of the rumours growing and spreading, and acquiring weight, are maybe slim. But it is worthwhile to be careful.

See the FT, Risk magazine, and the Economist for details.