What Spain’s election and S&P’s Italy rating mean for bonds
Senior Fixed Income Strategist
Summary: Both the Spanish general election and the S&P rating review of Italy caught investors on the wrong foot, as the socialist incumbents look set to retain power in Spain and Italian debt has avoided another downgrade.
But the losses of last week soon reversed as the market turned bullish again as S&P confirmed a rating of BBB for Italy and socialist Pedro Sánchez won the election in Spain.
So far today we’ve seen investors taking on risk in the periphery. Spanish 10-year sovereign bonds are currently trading at 1% in yield, which is the lowest we have seen since autumn 2016. We expect 10-year Spanish bonds to trade even tighter as political events are not worrying investors any longer and the economy is performing relatively well compared to its peers. On the other hand, although Italian BTPs have been rallying after the rating announcement by S&P, they have traded relatively flat since the beginning of the year.
The big question is will the periphery continue to perform in the long run?
Probably not, as much depends on factors such as inflation, the performance of the German economy, global growth, political uncertainty in Italy and most importantly, who will succeed Mario Draghi as president of the European Central Bank and whether this new leader will be as supportive of the periphery as he was.
In the meantime, the troubling thing is that it seems that investors still like risky assets in and outside the periphery and although a status quo is expected to persist during the summer as central banks remain cautious and supportive of the local and global economy, things could take a nasty turn in the autumn if the global economy doesn’t improve and if Draghi is replaced by somebody with more hawkish views.