The day after the Constitutional Court’s ruling on the electoral law, the yields of Italian government bonds surged by over 10 basis points on maturities between five and 30 years, and by 8bps on the 3Y maturity…..
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Intesa Sanpaolo – Research Department For professional investors and advisers only
Spain was largely unaffected by this violent movement, and moved almost in line with the German market. The Italian spread vs. the 10Y Bund widened back to 177 basis points. In part, tensions may have been amplified by the coincidence with end-of-month auctions, at which the MEF also launched a new 10Y BTP.
However, it would be rash to ignore the signals of unrest that are emerging. The reason is that the ruling is interpreted as favouring the prospect of early elections by June 2017, an option which seems even more credible now as it is supported by a part of the government majority, in addition to the two main opposition parties. In theory, there is nothing wrong with this acceleration: given specific conditions, the scenario would aid the drafting of a more strategic Budget for 2018, and would prevent political uncertainty from peaking once the ECB starts to prepare the unwinding of the PSPP, which has hitherto allowed a reduction of exposure to the Italian market without repercussions on the cost of public debt.
The fact is that simulations based on voting intention data and on the current electoral laws, show that the formation of a government majority in Italy will be even more complex than it was in Spain in 2016, unless electoral consensus shifts significantly once again in the next few months: none of the feasible coalitions emerge as having a tangible chance of clinching an absolute majority of Parliamentary seats. Therefore, the prevailing perception among investors is currently that elections will do little to remove uncertainty, and that (like Spain in 2016), Italy may be forced to vote again a few months later – i.e. at a time when the markets may be at grips with the unwinding of PSPP – extending in the meantime the conditioning effect of the electoral cycle on economic policies. Obviously, the situation is not the same as in 2011: as we explained last week, the structure of foreign debt is more robust today (an important share of debt is owed to the Eurosystem rather than private investors), a smaller share of government bonds is held in foreign portfolios, and the euro area has equipped itself with several safeguard mechanisms which could be activated in the event of financial stress. Furthermore, considering the low starting level of rates, the increase of risk premiums would have to be exceptionally strong to push up the average cost of debt. Nonetheless, the heightening of specific risks could prompt investors to demand wider yields spreads than at present in order to be convinced to hold Italian debt.
As regards the future of the APP, different views were once again voiced this week by the German Council members, in favour of accelerating its narrowing, and others (such as the Frenchman Villeroy de Galhau) who stressed that inflation differentials reflect the differences between the economies of member states, and that monetary policy should instead reflect the overall situation in the euro area. In our view, the German members are not truly aiming to change the December decisions on the extension of the asset purchase programme; rather, they are setting the stage to promote a swifter tightening in the course of 2018.
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