RBS Says Sell Italy Bonds Before Vote as Berlusconi Gains

Royal Bank of Scotland Group Plc recommends investors sell Italian bonds before the Feb. 24-25 election, saying that further gains in polls by former premier Silvio Berlusconi may push the 10-year yield to 5 percent.

“The market is just another tight poll reading away from a more material sell-off,” senior rates strategist Harvinder Sian and strategist Michael Michaelides wrote in a note to investors yesterday. “Given the supply dynamics and positioning, we target 5 percent in the 10-year” yield.

Berlusconi, 76, whose political career was seen as over when he resigned in November 2011 with yields topping 7 percent, has narrowed the gap with front-runner Democratic Party leader Pier Luigi Bersani in recent weeks with promises to eliminate an unpopular property tax and refund last year’s payments. A poll yesterday by Tecne showed Bersani’s lead at 3.7 percentage points, within the margin of error of 4 points. Bersani led by 14 percentage points in a Tecne poll on Jan. 2.

“Our view has been that the market is rather complacent about the upcoming volatility in Italian politics no matter the outcome of February’s election,” the strategists wrote.

The most probable scenario remains that Bersani will win outright in the lower house of parliament and enter into an alliance with outgoing Prime Minister Mario Monti to build a majority in the Senate, they said. Italy’s 10-year yield, now about 4.6 percent, implies a 19 percent chance of a Berlusconi upset, and that probability may increase with further gains in the polls, they wrote.

“Given the trend in the polls, the market will assign a greater probability, and if the risk of a Berlusconi upset is one-third, then 10-year bond valuations should be 5 percent, while a 50-50 risk in the election puts the valuation at 5.5 percent,” according to the two strategists.

A Bersani-Monti government would push the yields down to about 4 percent after the vote, the said. A Berlusconi upset could push yields back toward the 7 percent level on expectations that Italy would carry out needed reforms only by being forced into the European Central Bank’s bond-buying program, they wrote.