Italian debt will sell like hotcakes, and Draghi knows it

Italy is feeding investors seeking coupon income in Europe

This week’s auction results are offering an important takeaway: the market will do anything for anything to get coupon income.

The new 50-year BTPS benchmark has offered that much-needed coupon income. On Wednesday, we saw order books swelling with €64 billion bids, the highest we have seen for long-term government bonds this week. Demand has been extraordinarily high because Italy issued the new bonds offering a yield of 2.15%, one of the highest in the European sovereign space.

At the same time, Italian government bonds have proved remarkably resilient amid the recent selloff in European sovereigns, falling only by 1%. In comparison, peers registered an average loss of 2%. Such resilience can be attributed to the fact that Italian sovereigns carry shorter duration, and that sentiment has improved since Mario Draghi entered in the political landscape.

Buying into BTPS with a 2.15% coupon might seem reasonable in light of rising interest rates globally. What doesn't look reasonable is seeing high demand for other European sovereigns that provide negative returns, thus are more exposed to interest rate risk. Yesterday, demand for the French 10- and 30-year Bonds was solid, however not justifiable in light of the fact that the yield offered was around zero. The French 50-year benchmark with maturity 2072 issued in January has fallen by 15% since issuance as interest rates risk weighs heavily on its duration.

We believe that Italian sovereign bond issuance will continue to strive because of the much higher return that these instruments provide compared to their peers. Still, their intrinsic risk profile will unavoidably rise as the financial sector becomes more dependent on the country’s government bonds, such as the Financial Times has pointed out.