With near-term focus on the rumblings from populists in France and socialists in Germany, investor attention to the real political threat arising in Italy has not received its warranted attention. Xtrade explains
When the last populist Italian Prime Minister initiated a standoff in 2011, 10-year government bond yields rose to over 7% (compared to some 2.4% now, double that of 9 months ago). At present the ECB is buying € 60 billion of Eurozone bonds monthly and has promised an unlimited (and untested) backup in the event of a financial meltdown, but bondholders are rightfully worried. General expectations of “tapering” are for it to occur in the coming year — likely to overlap Italian elections. The resulting dynamic may well produce a promotion of the populist upstart 5 Star Movement, who have called for a referendum on leaving the euro.
Already, the Italy-German Bond Spread is setting multi-year records:
Furthermore, the banking sector has regressed on the clarity of its risk exposure, supported by legislation to that effect. Former PM Renzi even promoted shares of troubled Banca Monte dei Paschi di Siena (MPS) on social networks. With the banking sector’s doubtful loans totaling some 360.000 million euros, a quarter of Italy’s GDP. Moreover, one third of all the non-secured bonds of MPS and other small banks are in the hands of small investors, whose haircut on any default would be severe.
The IMF does report that Italian productivity and labor market reforms give some hope for the economy, and last year’s failed effort at a minor constitutional tweak demonstrated how hard it is to effect even minor political changes. Yet, everyone, including Frankfurt ECB bankers, is concerned. Look for the ECB to modify its tapering as per Italian requirements. Nevertheless, the case for buying Italian bonds, at present, is thus less than compelling.