Italy’s Looming Referendum Risk Splits Southern Europe’s Bond Markets
Posted by hkarner - 23. November 2016
Source: The Wall Street Journal
Italian 10-year yields are now nearly half a percentage point above their Spanish cousins, the highest in five years
In the latest bond market selloff, a new trend is becoming ever more clear — a divergence between southern Europe’s two biggest economies, Italy and Spain.
Italian 10-year government bond yields are currently at their highest since early 2012, around half a percentage point above their Spanish counterparts with two weeks to go until the country’s constitutional referendum. In the selloff since the U.S. election, Spanish yields also ticked up, but at a slower pace than Italy’s.
The country goes to the polls Dec. 4 to approve or reject reforms to the country’s upper house of parliament. A “yes” vote would weaken the country’s senate, reducing its control over some policy areas and meaning it can no longer oust governments.
In times of economic stress, yields on the European periphery — the more economically troubled countries that suffered most during the euro sovereign debt crisis — tend to rise relative to countries in Europe’s core, particularly Germany.
“The significant underperformance of [Italian government bonds] in the last two months is by and large a reflection of the higher political premium in the run up to the Italian referendum,” said a note from Morgan Stanley’s interest rate strategists late last week.
A loss — currently projected by most polls — would weaken Italian Prime Minister Matteo Renzi’s economic reform efforts. Earlier in the year, Mr. Renzi suggested he would resign in the event of a “no” vote.
Italy’s brand new 50-year bond is another illustration of the challenge for investors. The debt security has dropped in price by more than 12% in the last month.
But it isn’t just a relative absence of political crisis that’s helping Spain — the country’s economy has also shown more strength than Italy’s. HSBC’s analysts believe that in time Spanish bond yields could converge towards French levels.
Spain was considered one of the most damaged European economies during the eurozone sovereign debt crisis, but has rapidly repaired its reputation among investors.
Though the economy took an enormous hit during the euro crisis, the country’s GDP per capita is still 14.2% higher than when the euro was launched in 1999, whereas Italy’s is 3.8% below those levels.
“With the political situation in Spain having turned less uncertain lately, the looming December vote has driven Italy’s policy uncertainty higher,” said Bank of America Merrill Lynch analysts in a recent note.
“We are no longer in the peace and quiet’ of 2015,” the note added. “From now to the referendum, we think Italy will be walking on thin ice.”