2. Political uncertainty remains and will continue to be a recurrent problem.
Uncertainty within the Italian political scene has always been an issue. Thus, we are not surprised that there are some hiccups also with Mario Draghi at the government.
The main problem is that the current government is a coalition of many diverse parties, including the PD (Democratic Party), 5 Star Movement, Forza Italia, the Northern League and other minor centre and centre-left parties. Mario Draghi is poised within this very fragile equilibrium to enact key reforms demanded by the European Union. However, Matteo Salvini, head of the Northern League, recently said that the current government would not have a chance to enact such reforms. His party is looking to push Draghi to the country’s presidentship at the beginning of 2022, forcing the country into an early election.
Such a scenario can be concerning because Salvini’s Northern League party is leading recent polls (21%). Polls also suggest that the second biggest party is Brothers of Italy, a national far-right conservative party led by Giorgia Meloni, which is gaining support by the day. Therefore, it opens up to the possibility that Eurosceptics will lead the next Italian government, which would make the relationship with the EU problematic.
In our opinion, the political backdrop of the country remains solid as long as Draghi is Prime minister. Although a conservative government represents a threat, we believe it’s too early to price it in BTPS as things can rapidly change.
3. The economy is gradually opening
As the economy reopens and restrictions are lifted, we can expect growth to pick up. Higher growth and sustained inflation levels imply that the central bank will need to withdraw stimulus and eventually hike rates gradually. This is why news of a successful Covid-19 vaccination campaign and the economy reopening sends interest rates up.
Italian BTPS are becoming more and more desirable
As BTPS offer higher and higher yields, the more compelling they become compared to peers for the following reasons:
- Smaller investors will look to use BTPS to park cash to avoid negative interest rates on deposits. Italy is the only European country offering a positive yield starting from four years up. To secure a positive yield in Portugal and Spain, one will need to go beyond a 6-year maturity. French OATs pay a positive yield from eight years onward.
- Real money will find it difficult to find better risk/reward in the European bond space. Investors with long-term investment horizons such as pension funds and insurances will find that Italy is currently offering the highest yield in the European region. Italian BTPS provide even a higher yield than Greek government bonds, which are rated junk. Ten-year BTPS pay 1.1%, while 30- and 50-years bonds pay a solid 2% and 2.5% in yield. In comparison, according to Bloomberg Barclays indexes, high yield EUR corporate bonds offer an average yield of 2.5% for three and a half years duration. Investment-grade EUR corporate bonds provide on average a yield of 0.38% for an average duration of six years.
- Italian inflation linkers are less expensive than peers. As inflationary pressures are resurfacing, investors are looking for protection. Unfortunately, investors will find European inflation linkers incredibly expensive, with Germany providing a negative yield of almost -2%. Within this context, Italian inflation linkers shine. Ten-year Italian inflation linkers BTPS provide a slightly negative yield of -0.2%, allowing investors to get protection cheaply compared to other EUR linkers.
When looking at Italian BTPS, it is essential to understand that yields are destined higher precisely like all other European sovereigns. It means that all sovereigns in the euro area, including Italian government bonds, will lose value. Therefore, it is necessary to look at BTPS as a buy-to-hold opportunity. Within this context, investing in European sovereign ETFs could prove dangerous. Indeed, the mark-to-market value of the fund's holdings will continue to fall, while their ultra-low coupon payments will not balance out losses.