LONDON Euro zone bond funds are pointing the finger at speculators for kickstarting a shock sell-off in Italian government debt that they may well be forced to join if spreads continue to widen at such an alarming pace.
Fund firms running more than 1 trillion euros in fixed income assets are wrestling with fears for the security of their exposure to Italian sovereign bonds amid fears Europe's third largest economy could succumb to contagion from the debt woes of Greece, Portugal and Ireland.
These investors, who are major buyers of European sovereign debt, told Reuters they have few doubts about Italy's solvency but the slow progress of Greek bailout talks was eroding confidence in the economic stability of almost any Euro zone member.
"I don't think we are really looking at Italy and Spain and maybe Belgium in isolation any more. We're really looking more at the EU area as a whole because I think we are fighting for the survival of the euro," Sylvain de Ruijter, head of core fixed income investments at ING Investment Management said.
"We have only sold down a very small percentage of our Italian and Spanish debt exposure but it is fair to say that we are reviewing the level of ownership of these credits for all our clients," de Ruijter said.
Yields on 10-year Italian government debt jumped 30 basis points to break 6 percent for the first time since 1997 on Tuesday, edging closer to a 7 percent threshold after which Italy is broadly seen to lose the ability to finance itself, analysts reckon.
The jittery marketplace for Euro zone sovereign bonds has provided the perfect incubator for hedge fund bets on ballooning spreads and subsequent currency movements, the fund managers said, forcing the cost of insuring Italian debt against default to record heights.
Olivier Larouziere, fund manager of the EURO Sovereign bond fund at Natixis Asset Management, said the spike showed short-sellers had the power to infect much larger and stronger economies as well as more indebted peripherals.
"The contagion strategy has been implemented by many hedge funds, first on Portugal, which has seen spreads move out very violently; as is the case with Spain. But Italy is coming as a shock to everyone because it was not on the list," he said.
"We have a neutral view on Italy because we think that fundamentals are solid. To my mind there are some very opportunistic trades out there... but believe me, I would not hesitate in having no Italian bonds if I truly thought a default was inevitable," Larouziere said.
Eric Brard, head of fixed income at Amundi, the asset management unit of French banks Societe General and Credit Agricole, said his decision to cut allocation to Italian debt was motivated by a desire to sidestep market turbulence than fears for an Italian bond default.
"This is a very marginal part of our investments and has nothing to do with our view on its solvency or liquidity, it is rather a view linked to market volatility," he said.
One executive of a multi-billion dollar hedge fund firm, however rejected the theory that his sector was responsible for the dramatic moves, saying hedge funds appeared to be focusing their activity on Greece, Spain and Portugal, rather than Italy -- at present.
The managers agreed the structure of the Euro zone had rendered individual member states powerless to confront fiscal and economic weaknesses that were often unique to them.
Andrew Bosomworth, head of fixed income portfolio management in Germany at Pimco, a unit of Europe's biggest insurer Allianz, said his house was underweight in Italian debt because it didn't have the necessary freedoms, such as currency depreciation, that might help it manage its swollen debt pile.
The country carries national debt of 119 percent to gross domestic product (GDP).
"Italy is solvent, it needs to get back to a primary surplus to remain solvent. I am confident it can do that. There is just one problem; notice the structure of the monetary union where countries cannot devalue their currency," he said.
Bosomworth said the implementation of reforms that promote business growth could be the best signal Italy could send to a market concerned about its sluggish economy, echoing suggestions it should follow Spain's example and be more transparent about its austerity plan.
The traditional argument that Italy can count on a pool of domestic savings large enough to fall back on in a crisis, is no longer enough to reassure fickle investors, de Ruijter said.
"If they get nervous and stop buying who knows what the future brings? Even Italian investors are wondering whether it is very rational for them to take out their money and put it into a German or French bank," he said.
(Additional reporting by Laurence Fletcher; Editing by Mike Nesbit)