Italian century bonds: why not?

Bonds
Althea Spinozzi

Fixed Income Strategist

Summary:  This year, by refinancing maturing debt at current rates, Italy could save up a total of EU41 billion in the next fifteen years. The spread compression that Italian sovereigns are benefitting from is a rare opportunity for the government to issue cheap debt with long maturities. We believe that the country will benefit from looking at the possibility to issue debt with maturity beyond 50-years. A centenary BTP will most likely price with a yield of 2.5%, which is roughly the average yield offered by 3-year BTPs in the past twenty years.


Southern European countries are taking advantage of upbeat market sentiment by issuing long-term debt as Draghi enters Italian politics. Yesterday’s strong Spanish 50-year bond issuance attracted more than €65 billion while offering only 1.458% in yield. Spain was not alone in doing that this year. In just a little over a month since the beginning of the year, Belgium and France issued 50-year government bonds, while Slovenia issued 60-year sovereigns. Demand was extremely high for all of these bond issuances. Order books exceeded €75 billion for the May 2072 OAT which offered only 0.6% in yield. Slovenia attracted orders covering more than 8.6 times the issuance of 60-year government bonds, offering a yield of 0.7%.

It is not a secret that since the Covid pandemic, investors have not been afraid to extend their portfolio duration to get some extra yield. Demand for ultra-long maturities has increased due to their high convexity as it enables bonds to benefit from a more significant increase in bond prices amid a sharp fall in yields compared to shorter maturities. We expect this strategy to continue to provide considerable upside throughout 2021 as a resurgence in Covid-19 cases will force the European Central Bank to increase monetary stimulus. Although demand for ultra-long and perpetual debt is exceptionally high, supply continues to be limited. Hence, this is the right time for countries to expand bond issuance in ultra-long maturities to fund budget deficits while securing extremely low yields. An opportunity that we believe a country like Italy cannot ignore.

In 2016, Italy issued 50-year BTPs offering a coupon of 2.8% (IT0005217390). The same bonds today offer a yield of 1.7%. If the country were to come to the market with a new 50-year BTP, it will most likely price between 7 to 15 basis points over the old benchmark, securing a yield of around 1.8%.

We strongly believe that the convenience of issuing debt on the long part of the yield curve should push the Bank of Italy to look beyond the 50-year maturity and even to consider a centenary bond. Although rare, centenary bonds have been quite successful debt issuances. Last year, Austria’s century bonds were eight times oversubscribed despite offering just 0.88% in yield. The same bond today is trading with a yield of 0.65%.

A century BTP could offer roughly 2.5% in yield

We believe that 100-years Italian government bonds could price between 80 and 100 basis points over the benchmark 50-year bonds' yield. The graph below shows that a 100-years BTP with a yield of around 2.5% (orange dotted line) would imply a substantial steepening of the yield curve, which can be explained by the Treasury's need to compensate for the convexity such long duration would carry. In the most bullish scenario, new ultra-long bonds would follow the yield curve's existing inclination. Thus, a centenary bond would provide a little over 2% in yield (grey dotted line), roughly 50bps over the existing the 50-year benchmark.

To put things into perspective, with the issuance of a centenary bond, Italy would be able to lock a yield around 100bps lower than the average yield offered by 10-year BTPs in the past 20 years, which was around 3.68%. BTPs with a tenor of 3 years have offered an average yield of 2.4% since 2000.

Many are quick to point at Mario Draghi's entrance in politics as a favourable turn for the BTPs. Yet, spread compression was a well-established phenomenon caused by the ECB expansionary monetary policies way before the former president of the ECB was involved in Italian politics. We believe that Draghi has accelerated this trend providing an unprecedented opportunity to the country to take advantage of positive market sentiment and historically low yields.

This year the country will need to refinance around EUR 341 billion of existing debt. Assuming that the tenor of the new bonds will match the one of those expiring and that the country will be able to issue debt at current market levels, Italy is poised to save a total of EUR 41 billion in the next fifteen years. As the BTP-Bund spread continues to tighten, the advantage to refinance debt becomes more prominent.

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 is not intended to and does not change or expand on this. 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-hk/legal/disclaimer/saxo-disclaimer)

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract) and Type 3 Regulated Activity (Leveraged foreign exchange trading) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong

By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.