Investors should remain wary of Italian sovereign debt Investors should remain wary of Italian sovereign debt Investors should remain wary of Italian sovereign debt

Investors should remain wary of Italian sovereign debt

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

The human mind works in mysterious ways. Sometimes we see beyond things, while other times we cannot see things at all and continue to make the same mistake over and over. A great example comes from the Flat Earth Movement, which has of late begun to entertain the idea that Australia does not exist. Are any of your mates Australian? Well, you will be shocked to know that, in reality, Australians are computer-generated personas.

Speaking personally, I have just had to face the realisation that my Sydney-based Saxo colleagues are fact simply Denmark-based people who enjoyed telling lies about white sand beaches and kangaroos.

This conspiracy theory might sound extreme, but it’s a good example of a much broader phenomenon. Although we can see and touch our Australian friends, and can even fly to Australia, some people still believe that it’s all a colossal fake. I believe that this is what we have seen happening in financial markets for some time now, and although investors are seeing clear signs of distress in the bond market, they are still holding on to their investments in the hope that things will settle down and evolve as they have done over the past few years. 

Unfortunately, things are different now. Although central banks remain a big presence in financial markets, their policies will not be enough to support valuations in the fixed income and equity markets as political uncertainty continues to intensify.

Although trade war is now the most obvious risk that investors are trying to price in, it seems that European investors have quickly forgotten about the shivers that Italy sent to the market when its politicians seemed unable to form a new government just over a month ago.

These shivers, which had a great deal to do with the fragility of the European Union in the face of a populist, eurosceptic government in Rome, appear to have receded from many investors’ minds and plans. Last weekend’s municipal elections, however, show that the populists are gaining ground and strengthening their position in Italy.

There is precious little reason to imagine that anything has really calmed or returned to ‘normal’.

One could easily call the results of the municipal elections’ second round extraordinary: the city of Terni, which has been a left-wing municipality for 20 years, has now passed to the right-wing League. The cities of Imola and Avellino, which were also governed for 70 years by the left-wing party, have now elected a candidate from the populist Five Star Movement.

Siena, which is home to Banca Monte dei Paschi di Siena bank, has also historically a left-leaning municipality. Now that a member of the right-wing coalition has been elected, however, uncertainties concerning the bank’s stability are on the rise. 

The League is the clear winner of the second round of municipal voting. It seems that Interior Minister Matteo Salvini’s ‘Italians First’ approach and hard line on immigration is winning Italians over. The right-wing party won 42 out of 109 municipalities; before the vote, it only held power in 23. The biggest loser is the left-wing party, which used to have 57 municipalities and now has only 31.

These municipal elections are extremely important because they have confirmed the undisputed majority of the Five Star Movement and League parties, both widely recognized as eurosceptic. We can expect these parties to try to advance their policies and brush against the public debt reduction question as we approach the 2019 budget deadline this autumn.

More volatility ahead for Italian sovereigns

As we get closer to the approval of the 2019 budget, we expect volatility to hit the short part of the Italian sovereign curve the hardest. As you can see on the chart below, the 2011/12 debt crisis saw two-years Italian sovereign yields spike faster than their 10-year counterpart, and we believe that this could happen again if investors perceive higher risks related to debt repayment. 

Longer maturities will also react to volatility, but we expect them to be more resilient due to the fact that investors are going to perceive more immediate risk in the repayment of short-term maturities. 

Another area of caution is the subordinated debt from domestic Italian banks such as Monte dei Paschi, Ubi Banca, Banca Carige, and Banca Popolare. MPS is of particular concern as the bank is now more exposed to policies set by the new populist Italian government. The Italian lender was mentioned by both the Five Star Movement and League in their campaigns, as they believe that the state-owned bank should better serve the Italian people. As a consequence, MPS subordinated debt issued in January this year with maturity in 2028 has widened by 560 basis points since issuance, hitting a high of 11% in yield last week before the second round of the municipal elections. 

The only headlines that could have a positive impact on the Italian lender are those concerning a potential acquisition, which seems to be under consideration by Credit Agricole. We believe that if an offer comes from the French lender, the Italian government will prove inclined to sell its share in MPS as it would be then able to invest more resources into the policies at core of their political agenda.

We remain constructive on the subordinated and senior debt of bigger Italian lenders such as Unicredit and Intesa Sanpaolo, which are well-diversified internationally with large but limited exposure to the domestic Italian market. We believe that already now senior and subordinated debt of the two banks offer interesting returns, but we should see better buying opportunities as we get closer to the 2019 budget approval in October as credit spreads should widen further in light of public debt talks.

Finally, volatility in Italy most likely will spread to the periphery with Greece and Spain being the most probable victims. At the same time, we believe that Portuguese debt will continue to be quite resilient to Italian news as the nation continues to demonstrate that it has overcome the European debt crisis of 2011/2012.

Ten- and two-year Italian yields
Italian 10-year yields (blue) versus two-year yields (orange) — source: Bloomberg

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992