Investment Strategy

Yields Entice Investors back to the Italian Bond Market

The European Union is holding its collective breath while its largest debtor nation has used new found populism to allow Italians to rise above austerity at a cost that may be detrimental to itself and the EU as a whole. The rise of populism to power was based on promises to break with Italy’s discredited political establishment and help Italians left behind by the country’s long economic crisis. It’s quite amazing when you think that it was only the fourth quarter of 2018 that the Italian economy slipped into recession. The battered economy, enormous debt, and banking failures leave one to wonder what could bring investment back to Italy. The fact is that there is an unquenchable thirst for yield that investors chase around the globe.

Newly issued Italian government bonds have far exceeded expectations, a testament to the appeal of the country’s higher interest rates, which are near record levels relative to German rates. The yield on 10-year Italian government bonds was 2.80% Monday. The equivalent German paper yields just 0.11%, close to the widest spread between the two since the euro sovereign-debt crisis abated in 2013.

Those that will prevail in this market, if any, will assuredly by private banking fixed income professionals. In an interview with the Wall Street Journal, Dickie Hodges, head of unconstrained fixed income at Nomura, bought shorter-term Italian government bonds last year, including three and five-year paper, which he sold when markets rallied last month, and recently bought 30-year Italian government debt. The circumstances around the allure of Italian debt are succinctly summarized by Paul Brain, head of fixed income at Newton Investment Management, a subsidiary of the BNY Mellon. He explains that there is money needing to be parked in higher yielding bonds, by stating, “A whole pension industry and insurance industry in Europe is trying to put their money somewhere.” Well, there is reason number one. He goes on to say the painful truth that like gamblers, investors can’t say no. “We don’t like Italy because of the amount of debt they have, their ability to pay that debt, but they offer a yield you can’t get anywhere else.” There you have it.

Economic growth in Italy for fiscal 2021 has been downgraded from 1.20 percent to 0.20 percent. Most economists will tell you that the macroeconomic picture is gloomy and many do not see a turn-around any time soon. With declining industrial production not only in Italy, but in the entire European Community, bond holders will need to buckle-up for what looks like a downward spiral in the not so distant future.

Industrial production: Change from the same month a year earlier

One ray of sunshine has fallen upon the Italian banking industry as a result of renewed interest in Italian debt, as the banks have been at the center of investors’ concerns about Italy. Always optimistic, investors are putting faith in a more stable Italian political system, thus producing market stability. If the past is any indication, I will say again, good luck with that.

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