Italian debt puts spotlight on tensions in eurozone
• Investors home in on nation’s bonds because government’s weak finances add to shared risk across region
Italian debt is once again the must-watch bellwether for growing tensions within the eurozone. Global investors have lasered in on the nation’s bonds because, while they feature tempting yields, the government’s relatively weak finances add to the shared risk across the region.
UniCredit estimates the exposure to Italian government bonds by foreign asset managers and hedge funds may be the lowest since December 2018.
It is a familiar story — albeit with a new twist. Every now and then, concern that the eurozone will break up drives investors to question whether holding the region’s assets is worth the risk. This time, economies are facing one of the most difficult challenges in living memory due to pandemic-induced shutdowns, adding to strains in the bloc that are likely to show up first in Italy’s bonds.
“We’re avoiding Italy at the moment because it’s probably that country where a lot of the political issues play out in the market,” said Bill Campbell, a portfolio manager at Los Angeles-based DoubleLine Capital, which oversaw $136bn as of March.
“Italian government bonds are going to express that risk first and foremost, so we are out of that market until we get clarity,” he said.
DoubleLine’s global bond fund is underweight on all core and periphery European sovereign bonds.
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Investors were already exasperated by the euro area’s response to the spread of the coronavirus, and the damage it has wreaked on economies in the region, when a German high court gave the European Central Bank (ECB) three months to fix its €2.7-trillion public sector purchase programme that started in 2015.
It spurred concerns that more lawsuits may be filed against the ECB’s other vital programmes, which have kept markets buoyant through very turbulent times. German exports fell 11.8% in March, the most since at least 1990.
The policymaker’s bondbuying programmes — worth more than €1-trillion this year — are why Italy’s 10-year bonds are yielding about 2% and not 7.5%, the level they climbed to less than a decade ago when its membership in the currency bloc was in question.
Indeed, the ECB’s support is the main reason Philadelphiabased Brandywine Global Investment Management bought Italian debt. It completed purchases of 10- and 30-year so-called BTPs on Tuesday, according to Jack McIntyre, a portfolio manager.
The company, which oversees $60bn in assets mostly in bonds, did not own any European sovereign notes before the crisis. That was because they were not attractive given the negative yields.
The court ruling also highlighted the growing divide in the bloc and a stubborn problem with Europe: that it lacks the combined fiscal infrastructure to match its joint monetary prowess.
BOND ISSUANCE
Case in point, the region’s leaders have struggled to agree on a joint bond issuance across member states, which would help countries such as Italy, where debt is well above the nation’s economic output. On Friday, euro-area finance ministers agreed to allow the region’s bailout fund to extend an estimated $260bn in credit lines to each of the bloc’s governments on concessionary terms as leaders seek to cushion the economic blow of the pandemic
“We’ve been trying to have a cohesive Europe since the 1960s,” said Jeremy Leach, CEO at Managing Partners Group, which has hedged its exposure to the euro.
“But I somehow feel that if they have a referendum in Italy or Spain today, populations might vote to leave.”
He started reducing his holdings of European stocks late last year because he didn’t think they were fairly valued. Leach expects a repricing of eurodenominated bonds as default risk rises and the common currency weakens.
Moody’s Investors Service on Friday held off downgrading Italy’s credit to junk from Baa3, the lowest investment grade. That’s on par with where Fitch Ratings knocked the nation’s credit score down to the previous week.
If Moody’s had decided to cut the nation’s rating to junk, Italy could have seen its bonds fall out of indexes, losing billions of euros of investment.
“Italian bond ratings can’t afford to fall,” said Eiichiro Miura, general manager of the fixedincome department at Nissay Asset Management, based in
Tokyo. “Japanese investors will be reluctant about taking new exposures at this stage.”
That is despite Italian 10-year debt now offering a yield premium of more than two percentage points vs domestic Japanese bonds, when adjusted for currency swings.
While the euro area will probably “muddle through, the tail risk of the euro breaking up has increased”, said Eric Stein, co-director of global income at Eaton Vance Management.
“You need a strong political will to keep this project going, and I’m surprised that we haven’t seen more cohesive policy or more integration after the previous crisis.”