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‘Bond voyage’ to Italy says fund buyer

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PWM Asset Management has cut its holdings of Italian bonds (BTPs) and equities to virtually zero as the political uncertainty generated by the rise to two major populist parties shakes the financial markets and puts a question mark on Italy’s membership of the European Union.

The firm’s chief economist, Mahnoosh Mirghaemi, said her portfolio was 100% out of Italian investments and would not buy any unless there was a clear view on the direction of the government.

Italy has been struggling to form a new government since inconclusive elections in March. Earlier this week Italy’s president Sergio Mattarella asked former IMF official Carlo Cottarelli to form a technocratic government until a new vote could be organised.

On Wednesday the two biggest parties in the Italian parliament, the Five Star Movement and The League, were reportedly back in talks to try form a new government and avoid fresh elections, though it was unclear how successful these talks would be.

Meanwhile markets have reacted to the unfolding events in spectacular fashion with two-year Italian bond yields on Tuesday recording the largest rise on an intraday basis since records began in 1996, according to newsagency Reuters.

Increasing yields

“The whole country to me is at risk and the truth is the only the ECB can back them up and they said that they would,” Mirghaemi said.

However, she noted that the ECB had announced on Tuesday that it would only help Italy’s liquidity problems if the country  actions met the bank’s mandate and that Italy knew these rules.

“Italian bonds are giving good yields at the moment and this along with financial markets going through volatility due to tweets between [US President] Trump and North Korea, it is making the whole market nervous again,” she said.

“Last month we had earnings season and the market was getting better but then this month we didn’t have that and so the market attention went completely into political and geopolitical news and headlines.”

Over the past month Italian 10-year bond yields jumped 137 basis points and is at its highest (3.16%) since September 2013, according to Bloomberg data.

Italian 10-year bond yields six months to 29 May 2018

Italian bond yields 6 months to 29 May 2018

Source: Bloomberg

“All the European banks lost a lot during the last 10 days because of Italy. While the bond market at the moment is not signalling a huge crisis, it is showing unrest and because of that, the equity market will follow the bond market,” Mirghaemi said.

“Italian bonds are giving high yields compared to other European bonds so it could be a good investment if you’re looking for yield. These investors might think the ECB will be the light at the end of the dark tunnel.

“But for me I would say to reduce Italian bonds 100%.”

Amundi Asset Management’s head of euro govvies and inflation, Isabelle Vic-Philippe, said because Italy’s political situation was unclear investors would continue to demand a significant uncertainty premium.

“In the meantime, a short position on Italy is quite costly – 200bps on a 10-year bond would cost 66bps of carry until October – that should prevent any strong spread widening,” she said.

“At the same time, we expect a limited spread reduction until the next election. The next auction, early this week, will give a first indication of investor split and appetite. Until then, we believe it is worth keeping a neutral view on Italian debt.”

Italian bond auction

Mirghaemi said she was also waiting to see the result of Wednesday’s bond auction and said the best outcome would be for Italian banks to reinvest into the BTPs.

“The total value of the five-year and 10-year bonds is about €4bn. Based on what I saw on Friday, which was redemptions of around €18.5bn, tells me there is some light at the end of the tunnel and that has nothing to do with politics,” she said.

“The problem will be lack of liquidity, and to solve this problem the banks should reinvest.”

She said reinvestment by the Italian banks was likely and that economic data showed that the country was not in a bad shape but that it was a battle of the political forces.

The auction would define whether the market would be the engine for itself or if it was defined by political parties, she added.

Mirghaemi noted that the euro was “losing value massively because of Italy” and political issues in Spain were increasing bond yields, France’s economic reforms, Brexit, and the resurgence in Russia would not allow the ECB to just focus on Italy.

“Italy will have to do its homework for the auction, otherwise I don’t think anything will be positive,” she said.

“I hope Italy’s banks make reinvestments because then there will be reform. If this happens then the country will stay in the eurozone even with another election.”

Following Wednesday’s auction, Mirghaemi said BTP auction was neither spectacular nor disastrous, but that the bid-to-cover ratio improved.

The ratio was 1.48 times the amount offered but the 10-year bond was underbid by 25 cents which she said was not a good sign. However, 10-year demands was the highest since December.

Jassmyn Goh

Jassmyn reported from Sydney to New York to Jakarta before joining Expert Investor. She was most recently Features Editor at Money Management and Super Review in Sydney.

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