Investors Shun Italian Bonds as Political Outlook Remains Cloudy

  • Constitutional Court ruling plays against populist parties
  • Best scenario is a political deadlock, Aberdeen says

The Italian political outlook remains too cloudy for investors.

The yield spread on Italian 10-year debt over German bunds has risen faster than elsewhere in the peripheral euro area to 170 basis points, the highest since Dec. 5, the day after the rejection of former Premier Matteo Renzi’s reforms in a referendum. Italy’s Constitutional Court yesterday struck down parts of the country’s existing election law for the lower house, including a provision for a run-off vote, saying it should be held in just one round.

While that makes the prospect for the anti-establishment Five Star Movement gaining power less probable, the ruling doesn’t eliminate the risk of a potential political deadlock in the country, if elections were held, giving investors a reason to sell Italian government bonds. Their yield spread over Spanish bonds rose to the highest since 2012.

Below is a compilation of recent analyst comments on the potential market implications of the decision.

Analyst Views

  • Aberdeen Asset Management Plc is short BTPs. “We see early elections as being a risk. Although both the Democratic Party and Five Star are only polling around 30 percent and therefore wouldn’t reach the majority threshold, this decision increases the chances of further political instability. The best-case scenario for Italian politics is a return to a deadlock and no reforms or major policies are able to be passed. This would leave the economy very much open to negative shocks and further structural deterioration,” money manager James Athey said in e-mailed comments.
  • Royal Bank of Scotland Group Plc remains cautious on BTPs given the heavy supply and the uncertainty regarding potential 2017 elections, according to a note to clients. 
  • Old Mutual Global Investors is short BTPs, portfolio manager Nicholas Wall said in e-mailed comments; Italy is still not competitive as labor costs haven’t dropped, the banks’ balance sheets remain weak and given the reasonable chance of elections this year with little appetite for structural reforms.
  • Pioneer favors buying BTPs over Bunds and sees any weakness as a buying opportunity. With yesterday’s ruling, the chances of the Five Star Movement gaining the majority in an election have receded, according to Cosimo Marasciulo, its Dublin-based head of government bonds.
  • Barclays Plc said that the Constitutional Court ruling makes snap elections in the second quarter, which is the current baseline at the bank, more likely. Still, early elections should be considered a positive development as it would help to jump-start the reforms agenda, economist Fabio Fois said. Moreover, the decision to abandon the second ballot-run-off system reduces the likelihood that anti-establishment parties may be able to win an outright majority in one of the two Chambers, according to the bank.
  • Deutsche Bank AG sees the constitutional court decision as mixed in terms of market reaction. “On one hand, the short term chances of a populist/euro-skeptic Five Star Movement’s victory would have been boosted under a two-round system. Conversely, the risk of early elections under a system that would likely result in political deadlock is a negative,” economists including Marco Stringa wrote in a note to clients.
  • Banca IMI expects the political parties in the country to try to reform the electoral system on their own; reform needs an agreement between Renzi’s PD and Silvio Berlusconi’s Forza Italia and at the moment the positions are different.