Senior Fixed Income Strategist
Summary: Italian sovereigns are better positioned to benefit from a "Draghi effect" compared to corporate bonds if the former President of the European Central Bank is appointed Prime Minister of Italy. The 10- and 30-year BTP-Bund spread have the potential to tighten to test 2015 lows of 100bps and 120bps respectively representing a capital gain up to 7%. Finally, BTPs will benefit from the BTP-Bund spread compression regardless of Draghi. Nevertheless, in a non-Draghi scenario, the tightening will be gradual, forcing investors to hold on BTPs for longer.
I have written a lot about Italian sovereigns explaining why I like them compared to other European peers. However, I have never touched upon probably their most bullish scenario: Mario Draghi, the most dovish President the ECB has ever had, becoming Prime Minister.
Although it seems that a new majority led by Giuseppe Conte will be the most probable outcome, the market cannot discard the probability of a technical government led by Draghi. Such a result will send a pro-European signal provoking a fast tightening of the BTP-Bund spread. At that point, the only question will be "how much upside is there in BTPs"?
We believe that a temporary solution to the Eurosceptic threats coming from the Northern League and the Brothers of Italy parties will push the BTP-Bund spread to 2015 lows: 100bps and 120bps for the ten- and thirty-year spreads, respectively.
Specifically, the tightening of the BTP-Bund spread will translate into a 12 bps fall in 10-year BTP yields representing an upside of around 1%. As per the image below, this would be a move of equal intensity as seen last June, when the country was exiting from the first Covid pandemic wave. Yet, ten-year yields could potentially dive further falling as much as 19bps as seen last May, giving an upside of approximately 2% to 10-year BTP holders. Longer-term BTPs will benefit the most falling as much as 30bps representing a capital gain of roughly 7%. Still, their tightening will be more gradual, and this strategy will require investors to hold these securities for a more extended period.
Italian corporate bonds will also benefit from the news, but less than the county's government bonds as they trade inside the government debt. According to the Bloomberg Barclays Euro-Aggregate Italy Corporate index, they offer an average yield of merely 0.3%.
What happens if Draghi doesn’t become Italy’s PM?
No worries! The spread between the BTP and the Bund will continue to tighten irrespectively of Draghi. However, if the former President of the ECB becomes Prime Minister, the news would give an instantaneous boost to the BTPs. Otherwise, the tightening will be constant, but gradual as the ECB will be forced to add more stimulus to support the European economy. Indeed, the ECB will be the only game in town as a new fiscal package will not come while Germany goes through government elections.
AI: The good, the bad, and the bubble
While a deep recession may not be iminent thanks to central bank policy, interest rates will have to stay high for longer, and this will be accompanied by volatility risk from the unwinding of bubbles, especially within AI.
Steen Jakobsen,
Chief Investment Officer
The emergence of advanced AI systems is by far the most surprising event this year, turning everything upside down, while risks and benefits are debated. AI will also become an arms race between the US and China.
Peter Garnry,
Head of Equity Strategy
As China navigates global fragmentation, its cycle of technology application, productivity enhancement, and growth is threatened by US breakthroughs in generative AI, limited computing power, and geopolitical tensions.
Redmond Wong,
Market Strategist
Japan’s expertise in semiconductors and robotic integration could be the foundation of AI dominance. Combining two of this year's themes, Japanese equities and artificial intelligence, brings a wave of opportunities.
Charu Chanana,
Market Strategist
The AI fever has turned the technology into a darling, pushing crypto further into no-man’s-land. There are striking similarities between AI and crypto, and if these are to come full circle, AI won't be spared for bubbles.
Mads Eberhardt,
Cryptocurrency Analyst
Stocks related to artificial intelligence (AI) have appeared on investors' radars. Expectations are high, but it may be necessary to consider how to get exposure to AI in a diversified way.
Hans Oudshoorn,
Trainer Academy
The USD is on its back foot as markets celebrate an eventual Fed rate peak and steady long US yields. The stakes are even higher for the Japanese yen if longer major sovereign yield curves have to price in economic acceleration.
John J. Hardy,
Head of FX Strategy
While commodities, broadly speaking, have faced some tough months, a partial reversal during June could signal that the asset class is getting back on its feet with energy holding up and precious metals with upside potential.
Ole S. Hansen,
Head of Commodity Strategy
As inflation remains high central banks face hard decisions about whether they should keep hiking interest rates or stop. Meanwhile, the rise of AI creates bubble-like conditions that only make the decision harder.
Althea Spinozzi,
Senior Fixed Income Strategist
