Italy’s Political Pinch Begets Bargains for Bond Investors

Updated on
  • Debt has gotten cheaper relative to Spain’s before referendum
  • If ‘No’ vote wins, ‘The ECB is there and ready’: Pioneer

Italy’s gamble on passing a constitutional referendum is turning into a buying opportunity for some bond investors.

The country’s sovereign debt has become cheaper relative to its peers’ in the run-up to the Dec. 4 vote which, if rejected, threatens to destabilize the government. The yield premium investors demand to hold 10-year securities versus similar Spanish debt soared to its highest closing level in almost two years this month.

Yet for Pioneer Investments, that underperformance makes Italy attractive, particularly with its risk limited by the European Central Bank’s stimulus plan. That provides a “safety net” for Cosimo Marasciulo, Pioneer’s head of government bonds, who helps manage 220 billion euros ($242 billion) from Dublin. He bought some of Italy’s first-ever 50-year bonds sold earlier this month.

“On Italy, you need to separate the fundamental story from the market reaction,” said Marasciulo, who co-manages the Euro Curve 10+Year fund that has returned 11 percent this year, beating 94 percent of its peers. “If a ‘No’ wins, the ECB is there and is ready.”

Euro Shield

That’s become a familiar refrain in bond markets. The ECB’s 1.7 trillion-euro quantitative-easing program has shielded euro-area debt from political turmoil in Spain, Portugal and Greece since its launch in 2015. Even so, the recent upsurge in Italian yields may underscore a shift that has some investors heeding Europe’s divergent political risks, especially since speculation erupted this month over when the central bank may begin tapering its stimulus.

Prime Minister Matteo Renzi has repeatedly promised to resign should the referendum be voted down, but he has declined to be drawn on the issue in recent interviews. The reform would curtail the powers of the Senate -- including one that lets it bring down governments with a vote of no confidence -- with the aim of streamlining legislation and making governments more stable.

Most polls this month signal the referendum will be rejected, albeit by a narrow margin, and with about a third of voters still undecided.

Shrinking Spread

The extra yield investors demand to hold Italian 10-year securities over similar-maturity Spanish bonds was at 0.29 percentage point, down from 0.37 percentage point at the Oct. 10 close, its highest since October 2014. That’s still an appealing Italian yield for investors who figure the stress around the referendum had reached its limits, and that the yield will move towards where it’s been for most of the last five years -- below Spain’s.

The ECB’s backstop, together with the Italian government’s progress it curbing budget deficits, make JPMorgan Chase & Co.’s asset-management arm upbeat on the nation’s debt securities.

“Political risks will come and go, but ultimately when you look at the fundamentals there, Italy looks good,” said Nick Gartside, the London-based chief investment officer of fixed-income at the JPMorgan unit, which manages $1.7 trillion in assets globally. “Even if growth is a bit slow, the budget deficit is quite low in a European context.”

JPM’s Gartside likes both Italian and Spanish sovereign debt, “particularly longer-dated bonds.”

Pimco Prognosis

Pacific Investment Management Co., which runs the world’s biggest actively managed bond fund, sees opportunity to buy around the referendum. A ‘No” victory would see higher-risk European bonds underperforming, Nicola Mai, a Pimco portfolio manager and sovereign analyst, wrote in a note to clients dated Oct. 11.

“This could create opportunities to add risk at more attractive levels, especially in peripheral sovereigns,” such as Italy, which remain anchored by ECB’s quantitative easing, according to Mai.

The yield on Italy’s 10-year securities climbed as much as six basis points, or 0.06 percentage point, to 1.44 percent on Monday, its highest level since June.

Italy’s sovereign bonds have been the worst performers in the euro zone in month through Oct. 14, losing almost 0.6 percent, according to Bloomberg World Bond Indexes. Only Britain’s debt had a worse month among Europe’s largest sovereign-debt markets, with a loss of 2.1 percent as Brexit-related turmoil cut their appeal.

“We’ve liked Italy for a long time and we continue to like Italy,” JPMorgan’s Gartside said.