Head of Macroeconomic Research
Summary: We feel that markets are over-invested in the "Italian budget blowout" narrative, but our credit impulse indicator still confirms a negative view on the country's economy.
Decomposition of our Credit Impulse indicator reveals that the largest drop has come from non-financial corporations while the decline in the flow of new credit from households and NPISH is more limited. Based on more recent data about credit published by the ECB, we can expect a slight increase in the flow of credit from NFC at the start of Q3, but the trend remains weak and lower than in the euro area.
In July, year-on-year lending to NFC rose 1.2% in Italy, versus 4.1% in the euro area.
This sluggish trend in credit – which is certainly set to last – can be explained by NFC facing higher difficulties in light of rising interest rates, a deteriorating global trade environment, and an overly strong nominal euro effective exchange rate.
Qualitative data tends to confirm this negative view about the Italian economy. The Bank of Italy’s Ita-Coin, which leads industrial production by four months, is close to zero, indicating that a sharp decoupling from most other euro area countries has been taking place since Q3.
In more details, PMI have flagged the risk of a technical recession in H2 while business expectations are down to a five-year low. This confirms the scenario of broad growth stagnation in Q3. It is our view that this will seriously complicate the budget equation in Q4.
That being said, investors should refrain from overestimating the risk of Italy’s “hot autumn”. The lack of a unified message from the government over its upcoming budget along with economic weakness and higher interest rates at the global level will certainly lead to higher volatility in the next two months, especially when the EU Commission communicates its judgment on the budget on November 30.
However, as long as the risk of an Italian exit from the EU is low, bond market tensions should be contained. In previous years, we have observed that rising 'Italexit' risks caused a massive sell-off, such as the one seen at the end of 2016/beginning of 2017 when the risk of euro break-up was above 20%.
After a new hiatus due to the leaked 5 Star-League coalition deal last Spring, foreign investors were back this past summer – particularly Japanese investors, who were net buyers of Italian bonds to the tune of around €30m in July.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
