Italy Yields Seen Climbing as Renzi Gets Mandate: Euro Credit

Investors paid little attention to Italy’s political intrigue this month, focusing instead on early signs of economic recovery and the outgoing government’s commitment to budget rigor. That may start to change.

Borrowing costs fell to record lows at sales of three-year debt and one-year bills as a political feud pushed Prime Minister Enrico Letta from office and cleared the way for his chief antagonist, Matteo Renzi, to become designated premier. On Feb. 14 data showed Italy’s return to growth after more than two years while the government debt at 2.07 trillion euros ($2.83 trillion) was still the euro area’s second-biggest as a percentage of gross domestic product.

“Even if Renzi has pledged to be more incisive than Letta, new risks could arise from a possible government led by him, both in terms of political stability and the implementation of reforms,” Gianluca Ziglio, executive director of fixed-income research at Sunrise Brokers LLP in London, said last week. “Uncertainties over the political situation again risk prevailing at a time when we are finally seeing foreign investors returning to Italy.”

Italian Bonds

Italian bonds have rallied with those of the region’s other peripheral nations this year on optimism the euro-area economy is recovering from the sovereign-debt crisis. Italy’s 10-year yield fell six basis points, or 0.06 percentage point, to 3.63 percent at 5:25 p.m. Rome time after declining to 3.61 percent, the lowest level since January 2006.

Still, the yield premium investors demand to hold longer-dated securities has increased. The steepness of the yield curve is used by some traders as a measure of a country’s repayment risk.

“Investors at some point are more reluctant to go long on the curve,” said Patrick Jacq, a fixed-income strategist at BNP Paribas SA in Paris. “Investors that were a very strong support at the start of the year are now making a pause. If the new government offered evidence that further economic reforms are on the way then there would be more investors coming.”

The yield difference, or spread, between two- and 10-year securities has climbed to 284 basis points, from 279 basis points at the end of last year. The equivalent German measure has narrowed to 157 basis points, from 171 basis points. The difference between the two countries’ spreads reached 138 basis points on Feb. 5, the most since May, based on closing price data.

Steepness Reflective

“The steepness is reflective of both the credit risk premium and monetary policy stance,” said Harvinder Sian, a senior fixed-income strategist at Royal Bank of Scotland Group Plc in London. “The market has got more confidence in the European periphery. Italy is a slightly different story because of all the politics. We haven’t fully normalized.”

Last week Letta, 47, said he’s a man tied to Italy’s institutions and that he kept a “zen” composure as the government crisis unfolded. Renzi at 39 is impatient to shake things up, but that may not be enough to cut through Italy’s convoluted politics and put the nation’s economy on a sounder footing. Both men belong to the Democratic Party.

Similar Challenges

“The new prime minister will probably face similar challenges to his predecessor in building and holding together a government that can agree and enact reforms,” Fitch Ratings said today in a report entitled “Italian PM Change Higlights Political Volatility.” Fitch also said that the “uncertainty about the durability of governments and their capacity for structural reform and fiscal consolidation is one reason for the negative outlook on Italy’s ‘BBB+’ rating.”

On Feb. 12, two days before Letta resigned, the yield on Italian 10-year bonds fell to as low as 3.66 percent. The rate, which was at 4.13 percent at the end of last year, has tumbled from a euro-era record 7.48 percent reached on Nov. 9, 2011, three days before Silvio Berlusconi resigned as Prime Minister.

Yields on Italian notes due in as many as three years have also fallen most as those securities might be protected by the European Central Bank’s pledge to buy the securities of nations that request central-bank support.

The volume of Italian bond futures trades rose to the highest in almost a year on Feb. 13 as Renzi’s Democratic Party withdrew its support for the premier and urged him to quit.

The day Letta resigned Italy’s credit rating outlook was raised to stable from negative by Moody’s Investors Service, which cited the government’s financial strength and reduction of risks from contingent liabilities. At the same time, Dietmar Hornung, associate managing director at Moody’s in Frankfurt, said in a telephone interview that “we highlight that the growth outlook is quite subdued.”

Government Securities

Italy’s government securities returned 2.6 percent this year through Feb. 13, according to Bloomberg World Bond Indexes. Spain’s advanced 3.4 percent and Portugal’s gained 6.4 percent.

In a Jan. 2 interview with il Fatto Quotidiano newspaper, Renzi said Italy could breach the European Union deficit limit of 3 percent of GDP in return for a commitment to reforms able to attract foreign investments.

“Renzi’s ascendancy to the premiership would likely have a positive impact on the economy in the short term, providing a tactical buying opportunity for Italian sovereign bonds,” Brunello Rosa, head of fixed-income strategy at Roubini Global Economics, said in a Feb. 13 report. Renzi “would likely make a renewed push for reforms and take a more pro-growth approach to economic issues, perhaps at the expense of fiscal discipline.”

Renzi Mandate

President Giorgio Napolitano today gave Renzi a mandate to form a new government, leaving him close to becoming the youngest prime minister in the nation’s history. The two men met this morning in Rome.

The new premier “may well find that any administration he forms will be paralyzed on account of the the Democratic Party’s lack of a majority in the Senate,” said Stephen Lewis, chief economist at Monument Securities Ltd. in London.

Renzi’s party and its allies have a majority in the lower house, but he needs the support of other political parties to win the necessary confidence vote in the 320-seat Senate where the majority is 161 and defections among lawmakers close to Letta cannot be ruled out.

“He may be full of bright ideas but will have an extremely difficult time entering into the damn alliance which is the Italian parliament,” Marco Elser, a partner at investment bank Advicorp Plc in Rome, said of Renzi’s political outlook.

Before it's here, it's on the Bloomberg Terminal.