Italian bond yields at two-year lows show investors are confident the rally that started after Mario Monti’s appointment as prime minister will survive an election political pundits say is tough to call.
Monti ruled out running in the Feb. 24-25 vote at a Dec. 23 press conference, while saying he would “consider” being the prime-ministerial candidate for a party that adheres to his economic agenda. The technocrat leader said his economic policy, and not just a European Central Bank backstop, has helped lower Italy’s 10-year borrowing costs by more than 250 basis points since he came to power 13 months ago.
Monti’s announcement comes weeks after former Prime Minister Silvio Berlusconi reversed a decision to stay out of the race, before offering to stand aside if Monti would lead a coalition of “moderates.” Berlusconi is now campaigning against the Monti government, and both of them are seeking to combat surging support for anti-austerity, comic-turned-politician Beppe Grillo.
“It’s the most unpredictable election probably in the entire post-war period,” Federigo Argentieri, a political science professor at John Cabot University in Rome, said in a Dec. 23 telephone interview. “It’s not clear at all.”
The political upheaval hasn’t derailed a debt-market rally that sent Italy’s 10-year yield to 4.35 percent last week, the least since December 2010. The rate has fallen from about 7 percent on Nov. 16 of last year, when Monti was sworn in to lead a government of non-politicians. The yield rose 6 basis points today to 4.527 percent. The additional yield investors demand to hold the bonds over comparable German bunds narrowed to 289 basis points, or 2.89 percentage points, on Dec. 19, from 519 basis points in November 2011. That spread was at 316 basis points today.
“So far the impact of recent political developments on the Italian government debt market has been muted,” Barclays Plc analysts Fabio Fois and Giuseppe Maraffino wrote in a client note on Dec. 24. “Demand from investors has been solid across maturities and broad based among investor classes. The current positive momentum for the Italian paper should continue.”
Achieving a stable government that can keep a lid on borrowing costs is critical in a country that has the euro-region’s second-biggest debt load after Greece and must sell an average of more than 1 billion euros a day of bonds and bills next year. Italy sold 11.75 billion euros ($15.5 billion) of six-month bills and zero-coupon notes today, paying 0.949 percent on the short-term debt, near last month’s two-year low of 0.919 percent. The Treasury sells 6 billion euros of five- and 10-year bonds tomorrow.
Political headlines may cause volatility in Italian yields, Andrew Balls, head of European portfolio management at Pacific Investment Management Co., the manager of the world’s largest mutual fund, said in a Dec. 19 interview on Bloomberg Television’s “The Pulse” with Guy Johnson. “At wider yields we’d want to buy more Italy,” he said.
While Monti said in his Dec. 23 end-of-year press conference that it was his fiscal rigor and so-called structural reforms that helped rein in borrowing costs, the nation also benefited from an ECB pledge to safeguard the euro. The country’s bonds are up 16 percent since July 25, the day before ECB President Mario Draghi said he would do “whatever it takes” to keep the currency bloc together. He followed that in September with the outline of a plan to buy bonds of nations struggling to bring down borrowing costs.
Italy’s policies won Monti praise from German Chancellor Angela Merkel and Jean-Claude Juncker, who heads the group of euro-area finance ministers, though they have deepened the country’s fourth recession since 2001.
The measures have also pushed a growing chunk of the electorate to support the anti-austerity Five Star Movement. Beppe Grillo’s party would win 18 percent of the vote, according to a Dec. 10 poll by ISPO Ricerche. That compared with less than 10 percent for the coalition of three centrist parties running on a pro-Monti platform.
Berlusconi’s People of Liberty party had 16 percent, while Italy’s Democratic Party, which also backed Monti’s government, led with 33 percent, which may not prove enough to win a working majority in parliament.
“The markets are too complacent and they don’t appreciate Italy’s long-term political sclerosis, the probable absence of a strong majority after the election, the tendency of Italian politicians to speak well but act badly, and a worsening of the actual recession that could bring Greek-like problems,” Nicola Marinelli, who oversees $180 million at Glendevon King Asset Management in London, said in a Dec. 24 e-mail.
An inconclusive outcome in the election may prove to be Monti’s best path to a second term. Italy’s election law makes it difficult for any party to win a working majority in the Senate even if they gain clear control in the lower house, the Chamber of Deputies, meaning the vote risks producing a hung parliament.
Such a result may necessitate a sort of “grand coalition,” with pro-Monti factions within the Democratic Party and Berlusconi’s People of Liberty joining with the centrist parties that are openly supporting Monti in the election to form a government with Monti as its leader, John Cabot University’s Argentieri said.
“We will get a government that is acceptable to the market,” Luca Jellinek, head of European fixed-income strategy at Credit Agricole Corporate & Investment Bank, said in a phone interview on Dec. 18. “The so-called Monti agenda has made progress but it is incomplete. Italian bond yields will continue to fall.”