TwentyFour Asset Management
Since the two anti-establishment parties (The League and Five-Star) formed a coalition and took control in Italy, markets have been uncertain on the domestic government policy that was promising many things to many people and ultimately creating considerable friction with the European Commission (EC). Indeed, since the election in March 2018 the spread between 10y BTPs and Bunds showed steady divergence and exceeded 300bps in mid-October. However, since then and despite the turmoil and geopolitical uncertainty affecting global markets, there has been contraction, with the current spread differential being just over 200bps. Obviously, this has been helped by the expectation of further ECB stimulus, probably including another round of asset purchases, and also by a more conciliatory approach by the Italian government to the EU Commission. Earlier this year the EC threatened to start infringement procedures, due to Italy violating EU Budget rules (i.e. exceeding the 3% budget deficit ceiling), but after assurances from PM Giovanni Tria that the upcoming budget for 2020 would adhere to the rules, the threat of EU sanctions were suspended while political dialogue continued and details of the future budget plan clarified.
Over the summer the spread contraction between Italy and Germany has been particularly sharp (110bps over June/July) over which time the coalition have surprised many doubters by passing an array of popular macro and regional measures, resulting in a resounding victory for The League in the European election in May and an overwhelming victory in the Italian Parliament (160 vote majority) regarding security legislation, that has added to the expectation of an imminent general election. The latest rhetoric from Matteo Salvini suggests that he may now be confident of winning an election with an overall majority, thereby cutting ties with the 5-Star coalition partner and removing Giovannon Tria, the current finance minister. This would probably create some short-term volatility in BTPs, but longer term it is conceivable that a more conventional government will no longer have to promise a multitude of policies to satisfy a wide-ranging coalition (with left and right supporters) and hence, actually be supportive for BTPs over the longer term.
So while Italy and the EU still have their challenges, investors are recognising the relative value of BTPs compared to their EU peers. In July the domestic purchasing managers index recorded an unexpected pick-up in activity and the Bank of Italy’s leading indicator improved for the first time in 18-months (since the start of the new coalition government). We would also highlight the recent interim results of the leading domestic financial stalwarts, namely Generali and Banca Intesa. Within the past couple of weeks both have reported H1-2019 numbers with Generali reporting a 7.6% increase in operating profit and a combined ratio of 91.8%; while Intesa reported net income of €2.3bn (the best half year since 2008), net non-performing loans down to 3.6% and a healthy CET1 ratio of 13.9%; not bad given the weakness in the Eurozone and Italian economies.
We fully appreciate that Italy will remain a territory full or surprises and with downside tail risk to Eurozone fragmentation, however for investors with a flexible mandate there are some opportunities to be taken in the more liquid parts of the Italian bond markets while keeping a close watch on the political rhetoric.