Italian century bonds: why not?

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.