Italian Sovereigns? No Grazie

Bonds

Althea Spinozzi

Fixed Income Strategist

Summary:  Recession, economic stagnation and an unstable Italian government are some of the reasons why one shouldn't be happy to hold BTPs at record low yields. As volatility remains high, it is crucial to take a short-term stance on these instruments and actively trade them.


Whether you are looking to get a small interest rate on your savings or you are taking a speculative approach, beware from Italian sovereigns!

European taxpayers are getting overly concerned that negative interest rates are going to take away a chunk of their savings. Investing money in safe assets could enable them to avoid being charged with negative interests. However, with European sovereigns’ yield near zero, investors are pushed towards higher-yielding opportunities. The periphery, unfortunately, this time, will not come handy. Spain and Portugal offer approximately 35bps on their 10-year sovereigns, while Italy offers around 1% for the same maturity.

One can argue that 100 bps is better than negative interest rates. Nevertheless, if investors are thinking that buying into Italian sovereigns means not to be affected by market volatility, they are wrong.

Italian BTPs are perceived as a risky asset and do not function as a safe heaven. Whenever volatility is high, the market sells Italian sovereigns and seek refuge into the Bund. Therefore, if you are looking for stable returns and low volatility, this may not be the instrument for you. If you are taking a speculative approach, you have hit the nail on the head! Regardless, you have to keep in mind that at the moment BTPs are the most volatile European sovereign out there. If you want to be successful in trading them, you will need to focus on three critical themes.

  1. Recession. It won't be good, regardless of what the government says. 
    Roberto Gualtieri, Italy’s Minister of Economy, gave some good news last weekend at the Forum Ambrosetti: Italy's deficit will be smaller than expected this year. International and national statistical organisations were expecting the Italian deficit to range between 10 to 14% in 2020; but with the updated figures, it seems that it will end up to be below 10%. The news should have sparked a bullish sentiment in the market, but instead, what we have seen was a moderate selloff across the Italian sovereign curve. This can mean only one thing: the market doesn't buy what the government is saying. Probably, during the months of June, July and August, Italian GDP performed better than expected. Yet, we have still three months to go before the end of the year, and a second wave of COVID-19 might arrive suddenly. Whatever the deficit expectations are, the government will need to adjust them if another lockdown takes place.
  1. Nationalisations and government intervention contribute to economic stagnation.

    At the Forum Ambrosetti, Gualtieri also gave an idea on how the state is looking to put at work the recovery fund's money: digitalisation, innovation, infrastructures, education, health and decarbonisation. Nice words. But, is it actually what the government is actively doing? It doesn't seem so. From the national news comes a different picture to light: it appears that the Italian government is looking to nationalise. And, this doesn't give a positive signal to foreign investors. The Italian state has long years of experience in managing corporates poorly. One of the best examples is Alitalia, which struggled with profitability for decades (despite the crew wearing Armani!). Even with Ethiad as a new investor, the company was not able to take the necessary restructuring measures due to a backlash from employees and unions trying to avoid job-cuts.  The state had no choice other than to re-nationalise the airline in March after the airline began bankruptcy proceedings and auction efforts failed due to the coronavirus pandemic. We are risking to see the government playing the same game over and over, and rather than trying to modernise the economy, it will end up supporting failed businesses. Nationalisations will be bad for the economy in the long term because it will undermine business competitiveness and contribute to economic stagnation.

  1. Unstable government
    Giuseppe Conte has not been elected, he was appointed prime minister after the anti-establishment Five Star Movement (M5S) and the conservative Northern League (LN) reached an agreement to form a government in 2018. Since then, the Northern League has lost its grip on the government. The current cabinet is supported by the M5S, the centre-left Democratic Party (PD) and the leftist parliamentary group Free and Equal (LeU). It means that neither the prime minister and the supporting coalition were elected by the voters, making the current government particularly reliant on an agreement between parties. If this thin equilibrium is broken, the risk of another election becomes real.

Do not buy and hold BTPs, trade them actively

Investors can argue that regardless of how the Italian economy or government shapes up to be, there will always be the European Central Bank's support on the background. True! However, I believe that is crucial that Investors have a clear investment timeline in mind: how long are you going to hold on to Italian sovereigns? If you are thinking to buy long BTPs with the hope to get some yield and sell them in a couple of years to free up some cash, it may not be ideal. BTPs are more likely to fall in this period because of the risks outlined above.

However, suppose you are a trader and are looking to short BTPs. In that case, this may be the perfect time as there is plenty of reasons to be bearish, and we have reached a peak in terms of sovereign valuation (refer to the graph below).

Italian 10 Year Sovereign Yield. Source: Bloomberg.

How can I trade BTPs?

You can trade cash bonds of various maturities, but you won't be able to short sell them. In order to take a bearish view, you can look at Long-Term Euro-BTP Futures (FBTP) of different expiries. In the Saxo platform, it is also possible to find ETFs that enable investors to take a bearish view on Italian BTPs. One of these is the Lyxor BTP Daily (-2x) Inverse UCITS ETF (FR0011023621), which aims to reflect an inverse exposure leveraged to a multiple of 2 to the daily performance of the Italian Long Term Bond Market.

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