After several months of relative calm and a strong performance, Italian assets have again come under pressure following deputy prime minister Matteo Salvini’s stated intention to break his party’s fragile coalition with the Five Star Movement (5SM), analysis from Fidelity International reveals.
The sharp change in the political backdrop has seen investors quickly reprice BTPs, with the spread now at 230bps, widening 26bps in a day, according to Fidelity.
Prior to this, The European Central Bank’s guidance towards more quantitative easing (QE) had temporarily soothed concerns around Italian politics, with the ensuing search for yield pushing the spread between 10-year Italian BTPs and German Bunds below 200bps in mid-July.
With new elections now on the radar for autumn, and the lingering issue of the 2020 budget, Italian assets will remain under the spotlight, with risk premia likely to rise further in the weeks ahead, Andrea Iannelli, investment director, fixed income, at Fidelity International said.
We have held a cautious stance on BTPs for several months, wary of a sudden return of political risk
“We have held a cautious stance on BTPs for several months, wary of a sudden return of political risk. With these concerns materialising, we see BTPs remaining under pressure until there is more clarity on the new government and the budget,” he explained.
With most European government bonds offering negative yields, Iannelli acknowledged Italian BTPs can be attractive to income-starved investors, at the right price.
“Compared to previous episodes, the underperformance of BTPs may be less pronounced this time around, and we would look to pare back our underweight should spreads widen further than we expect. On the credit side, the sovereign-bank nexus is still strong. Italian financials are large holders of BTPs, and their bonds have a high beta to the sovereign,” Iannelli added.
However, for Italian national champion banks, the implications of wider BTP spreads on their capital position is less pronounced than in the past.
“Since the beginning of the year, our exposure to Italian credit, and financials, in particular, has been meaningfully reduced.
“This fits with our cautious view on the sovereign and generally expensive valuations. Italian national champion banks, however, have robust capital positions and any further weakness is a chance to add exposure,” Iannelli added.
As the political dust starts to settle, Fidelity predicts Italy will likely soften its approach and propose a feasible compromise to its political woes.
“A one-sided populist government, led by Salvini’s Lega party, would have less to deliver than a government split between two warring parties. This may bring opportunities at attractive prices,” the fund manager said.