Italy Losing Luster as Strikes Tarnish Debt Rally: Euro Credit

Italy's Prime Minister Mario Monti
Mario Monti, Italy's prime minister. Photographer: Kamoshida Koichi/Bloomberg

The Italian bond surge delivering better returns than oil, silver or the dollar this year will fade as the nation seeks to borrow 100 billion euros ($136.7 billion) in the second quarter against a backdrop of strikes.

Italian securities due in a year or more have outperformed commodities, currencies and other sovereign debt in 2012, when adjusted for volatility, as budget cuts by Prime Minister Mario Monti and European Central Bank lending spurred demand for the nation’s assets.

Now Monti risks splitting in his unelected government with a package of measures aimed at giving employers more powers to fire staff. Benchmark yields have risen as the reforms, endorsed by the premier’s cabinet on March 23, sparked a general strike by the nation’s main union and prompted threats from Monti’s Democratic Party coalition partners to reverse the law.

“The swing in sentiment was breathtaking, but the hurdle for continued outperformance of Italian sovereign debt lies quite high now,” said Frank Engels, a managing director of fixed income at Union Investment in Frankfurt, whose 46-member team manages 74 billion euros. “Should there be no consensus agreement on labor reform, the political factor could become a performance drag.”

In a study of 20 securities across a range of asset classes, Italian debt has only been beaten by the S&P 500 index, which has recorded its best start to a year since 1998, according to the Bloomberg Riskless Return Rankings.

Risk-Adjusted Returns

Italian debt has gained 1 percent since Dec. 31, when adjusted for volatility. That compares to a 0.9 percent advance in the dollar against the yen, a 0.6 percent rise in three-month Brent crude futures and a 0.5 percent return from silver. In the period the S&P index has risen 1.3 percent. German debt is little changed, while U.K. bonds slid 0.2 percent.

Last year, the debt of the U.K., U.S. and Germany offered the best risk-adjusted returns. Italian debt only beat the yen-dollar exchange, and Portuguese and Greek government securities, while the S&P 500 index was little changed.

“Italy outperformed others as it had the most room to,” said John Davies, a fixed-income strategist at WestLB AG in London. “The big test for Italy now, particularly versus Spain, is that it has only done half as much of its 2012 bond supply target as Spain has.”

Italian Issuance

The yield on Italian benchmark 10-year debt was 5.12 percent at 4:11 p.m. London time from 7.11 percent on Dec. 30. Two-year yields were 2.95 percent from 5.12 percent at the end of last year. The yield difference between 10-year Italian debt and similar-maturity German bunds, the region’s benchmark government security, has narrowed to 3.32 percentage points from 5.28 percentage points at the close of 2011.

Italy has fulfilled about 22 percent of this year’s borrowing needs, while Spain has sold 44 percent of its 2012 target, Davies said. Italy has issued a total of about 127 billion euros of all types of debt this year, while Spain has sold about 56 billion euros, according to data compiled by Bloomberg News. Spain has front-loaded its sales this year to take advantage of demand fueled by cheap loans offered by the European Central Bank, which handed out almost 1 trillion euros to regional lenders in December and February.

The Rome-based treasury will borrow about 103 billion euros in the second quarter, according to a Banca IMI research note published on March 27. Some 56 billion euros, or 27 percent, of the 2012 target will comprise bonds and notes, Sercan Eraslan, a fixed income analyst at WestLB, estimates.

Crisis ‘Almost Over’

The Italian 10-year yield reached 7.48 percent on Nov. 9, a euro-era record and higher than the 7 percent level that prompted Greece, Ireland and Portugal to seek bailouts. Monti was sworn in as Italian prime minister and finance minister a week later and pushed through a 30 billion-euro emergency budget package.

The euro area’s debt crisis is “almost over,” Monti said in Tokyo on March 28, adding that his nation had helped to stop a worsening of the situation, he said.

“Italy is the market that has the best risk-reward if you believe, as we do, in the positive outcome of the whole European crisis,” said Cosimo Marasciulo, the Dublin-based head of government bonds and currencies at Pioneer Investments, which manages 162 billion euros of assets worldwide. “There is still margin for more outperformance.”

Italian 10-year yields have risen about 50 basis points from their 2012 low of 4.68 percent on March 9 as Monti pursued his labor reform agenda.

Unless Italy is “ready for what we think is a good job, we may not seek to continue,” the premier said on March 26, prompting concern the government won’t last until elections due by May 2013.

“Italy now faces some hurdles of its own,” said Eric Wand, a fixed-income strategist at Lloyds Bank Corporate Markets in London. “The outperformance process has already started to run out of steam.”

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