Italy Two-Year Bond Futures Offer Peripheral Market Hedge, UniCredit Says
Italian short-dated bond futures may offer investors better protection against price swings in Irish and Portuguese debt than contracts tied to longer-maturity securities or German notes, according to UniCredit SpA.
The contracts, to be based on Italian securities with two to 3.25 years remaining before maturity, start trading on Oct. 18, Eurex, Europe’s largest derivatives exchange, said last month. The exchange introduced futures for 10-year Italian bonds in September last year to help investors hedge their holdings of government bonds issued by the region’s lower-rated nations.
Short-dated securities from countries such as Ireland, Portugal and Spain are outperforming their longer-maturity counterparts amid concern their governments may struggle to meet their financing requirements, said Luca Cazzulani, a senior fixed-income strategist at UniCredit in Milan, the biggest Italian lender. The yield difference between two-year Irish notes and 10-year bonds reached 3.19 percentage points on July 19, the most in a year, according to Bloomberg generic data.
“There’s a higher correlation between Italy and Spain, for example, than Spain and Germany,” said Cazzulani. “Trading activity at the moment is stronger on the relatively shorter maturities. That’s a factor suggesting a two- to three-year futures contracts would present a good trading opportunity.”
Italy, among the most indebted nations in the European Union based on debt as a percentage of gross domestic product, first offered a futures contract in September 1991, when its bonds were denominated in lire. The contract, traded on another exchange, was discontinued in 1999 after the euro was created.
The new Italian contracts, known as short-term euro BTP futures, will compete with the German Schatz contracts traded on Eurex. Futures are agreements to buy or sell assets at a set price and date. Investors can use the contracts to protect, or hedge, their investments against price fluctuations.
Demand for an alternative to German futures increased as the difference in yield, or spread, between the debt of peripheral euro-area borrowers and benchmark bunds widened to records amid the worsening sovereign debt crisis. The bonds of Italy, Spain, Portugal, Ireland and Greece are all rated less than AAA, the top classification by Moody’s Investors Service, Standard & Poor’s and Fitch Ratings.
Securities issued by Ireland, Portugal and Greece all have a negative correlation to German securities and positive correlation to Italian bonds, according to Cazzulani.
“This means investors using German bond-futures contracts to hedge against potential losses on Irish or Portuguese debt won’t be protected at all,” he said.
The daily trading volume of BTP futures rose to 5,433 contracts as of the end of September from 3,800 contracts last year. German two-year bond futures have an average trading volume of 569,000 contracts per day, according to Eurex data. Higher trading volumes, a sign of a liquid market, allow investors to buy or sell securities without distorting prices.
“German futures are still what I would call market- convention tools,” said David Schnautz, a fixed income strategist at Commerzbank AG in London. “Liquidity matters. The product might be innovative, but I strongly doubt it will fly very high.”
The BTP futures are liquid relative to the underlying bond market, according to Nadja Urban, a Eurex senior product manager. The notional trading volume of BTP futures was around 200 percent of the volume of the deliverable 10-year Italian bonds on MTS Italy, a bond trading platform, she said.
“That’s significant,” said Urban in an interview. “During the crisis, the underlying cash market nearly collapsed, but our BTP future remained liquid and was tradable without any problem. Market participants told me that the future was a reliable price reference throughout that time.”
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