Italy also has a long tenor of debt – almost eight years. This means it will take a long time for their coupons to re-price when rates come down, and conversely when they go up.
The country’s banking crisis has also been a point of concern and we don’t disagree that some banks need reform and recapitalisation, but these are mainly the smaller banks and the larger ones are in ok shape. And, as we have seen recently, much of this reform is already underway.
Economically speaking, the ECB will be unlikely to raise rates any time soon, and any removal of asset purchasing will be gradual, so we don’t see a disaster scenario for Italy.
Attractive yields on a relative basis
In an actively managed fund we are not constrained by any benchmarks. We make plays based solely on where we see best risk-return. Looking at Italy in comparison to Spain and France, we see a compelling proposition.
Currently, Italy is trading around 60 bps wide of Spain2. Spain also has some economic and political issues. While we do see some improvement in Spain’s debt to GDP and evidence of reform, we still see significant political risk which we don’t believe the market is correctly pricing in.
Since the election, France is back to trading 35bps over Germany2 but we think the fundamentals in France are very different to Germany. French debt to GDP is also going up faster than Italy, and unemployment remains high.
We also think the market is overoptimistic in its pricing in of Macron’s ability to conduct reform. We think it’s positive to see him secure a majority, but his party is only a year old and made up of both left and right, meaning he may come across some problems appeasing both sides of his government. Thus, we think France should be trading more in line with Spain than with Germany.
Outlook for populism
Looking forward, partly reinforced by Macron’s success in France and populist Geert Wilders failing in the Netherlands, we think the populist agenda has subsided for now, and, we see a shift in the Eurozone back towards support for the EU project.
However, we do not think the populist agenda is completely dead in the water. If the current elected centralist governments do not deliver we would not be surprised to see the populist movement re-emerge in the next election cycle.
- As of 31 May 2017, As of 30 June 2017, Italy holdings represented 20.65 % of the portfolio in comparison to the benchmark (Bloomberg Barclays Euro Aggregate Index) which was 15.60%
- As of the 14 July 2017 (Source: Bloomberg)
- The Italian 10 yr government bond is trading 169bps over Germany 10 yr Bund
- The Spanish 10 yr government bond is trading 105bps over German 10 year Bund
- The French 10 yr government bond is trading 27bps over German 10 year Bund
