Macro: Sandcastle economics
Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.
Head of Fixed Income Strategy
Summary: Italy's government crisis offers the perfect opportunity to enter in Italian government bonds cheap while continuing to benefit from ECB's accommodative monetary policies. We believe that even if the current government falls this afternoon, there is little probability that the country will go to early elections. The most probable outcomes are either an alternative majority or a technical government, which, rumours say, could be led by Mario Draghi. In both cases, we expect BTPs to continue to rally. Hence, we favour long maturities, especially 30-year BTPs.
Since the Second World War, Italy had 61 governments and 29 different Prime Ministers. That's why today’s government crisis is just a day like any other for Italians.
Don't expect public turmoil, because if Italians were not confined within their house walls today, they would rather drink a coffee in the piazza instead of marching in the streets of Rome.
Anyone well-versed in Italian politics knows that the power play started by ex-Premier Matteo Renzi will yield nothing different from what we already have today. Renzi, the Italy Alive party leader, is far from having the nation's support with only 3% in opinion polls. However, he can do damage as his support is crucial to the continuation of the current government.
At 17:30 this afternoon Renzi will let the public know whether he will withdraw support for the government. While a simple cabinet reshuffling seems unlikely, Conte and the Five Star Movement party (5SM) will look for an alternative majority in case of a lost majority in the government. Such a solution would most likely be accepted by President Mattarella, who in a time where the country is battling against the Covid-19 pandemic, will try to ensure government continuation and stability.
In case a new majority is not found, President Mattarella will explore the possibility to create a temporary government led by a technocrat. One of the names that have been floated around several times is one of Mario Draghi.
We exclude that early elections will be called as it would be political suicide for the current left-centre majority. Opinion polls are favouring the right-centre bloc. Additionally, a recent constitutional reform has reduced the number of parliament seats, meaning that many MPs will have little chance to be reelected.
In this environment, it is not hard to see that volatility is temporary and, in the long run, Italian sovereigns will continue to be supported by the European Central Bank's extremely accommodative monetary policies. Thus, we believe that the current selloff in BTPs represents an excellent buy opportunity.
Ten and thirty-year BTP yields have jumped to a level previously seen in November. Bond yields will probably fall to levels seen at the beginning of the year or even further once the political uncertainties are cleared. Long-durations will see the most significant upside; therefore, we favour Italy's 30-year BTPs (IT0005398406) over the 10-year BTPs (IT0005422891). Thirty-year BTPs are currently offering 1.50% in yield. If they were to fall by 10bps once a new government is confirmed, that would represent an upside of 2.2% in just a few days.
In the best-case scenario, 30-year yields will continue to fall approaching 1.2%, providing a total return as high as 7%. In case of a technocratic government led by Draghi, a new low in Italian sovereign yields could be achieved as fast as the first half of 2021. In other scenarios, the tightening of the spread between the BTP and the Bund will be steady, but slower.
Timing when to enter or exit an investment is as crucial as picking the right strategy. Although Italian BTPs have fallen considerably, there might be more room for downside as we approach this afternoon's press conference. In case Renzi withdraws his support this afternoon, but an alternative government has not been agreed upon yet, we can expect Italian BTPs to open in red tomorrow. Thus, it may be worth waiting a day to maximize the potential for upside as the lower Italian BTPs fall, the better the opportunity.
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