Italy is biggest threat to euro, says Europe's top bond manager

Italy, not Greece, is the main threat to the eurozone says global bond star Stewart Cowley, who also warns on the future of the dollar, believing the yen could become the world's safe haven currency.

Cowley, who is head of fixed income at Old Mutual Asset Managers, thinks Greece is too insignificant to threaten the future of the euro.

'Whilst we have all been preoccupied by The Greek Tragedy, we have somewhat missed the point. Greece is a tiny country with massive ratios but, in reality, it shouldn’t challenge the integrity of something as mighty as the euro,' he said.

Italy's situation, on the other hand, should give investors real cause for concerns.

'In actual money terms, countries such as Spain, Portugal and Ireland are but nothing compared to the gargantuan needs of Italy,' Cowley said. 'Each year Italians need to pay out (or borrow) over €35 billion just to meet their interest payments. And yet Italy has a debt to GDP ratio of 118% (second only to Greece’s 125%) and is much bigger in actual size. For instance, Italy has a bond market as big as that of Germany. We seem to have lost our sense of proportion as to where the real problem lies in Europe.

'So the elephant in the room is not Greece or Spain or for that matter Portugal, but Italy... clearly the borrowing job of Italy is much more a threat to monetary union than Greece. Maybe that’s why they have attempted to preempt criticism by signing off a budget that will reduce spending by €13 billion in 2011 and bring the deficit down to 3.8% of GDP.'

Cowley, who runs the Old Mutual Global Bond fund, thinks Italy's saving grace is that it does not rely on foreign investors as much as some of its other troubled counterparts. The rapid rise in annual interest rates is a common problem in many western nations, but Cowley thinks 'it pales into insignificance in comparison to the US.'

'The combination of a declining tax take and a rising amount of borrowing means that the annual interest costs of the US are now increasing at a geometric rate. In that sense, the only thing saving the dollar is the weakness of the euro, not the virtues of the dollar per se.'

'So if you are borrowing over $150 billion a year just to keep up with your interest payments, whilst, at the same time, the Obama administration is calling not for austerity and restraint but instead for another supplementary stimulus of $200 billion, you have to wonder how long the markets will continue to treat the dollar as a traditional safe haven currency,' Cowley said.

Cowley believes it is obvious that Greece will have to default on its debts at some point in the next couple of years. As a result he hopes markets 'don’t turn to the more obvious target of Italy in an attempt to blow the European experiment apart.'

He thinks that when 'the cloak of respectability is lifted from US finances', the yen could become the safe haven currency of the world as the sterling and commodity currencies are too small to accommodate international investors.