Italian Assets Show Little Panic Before Vote: Reality Check

(Bloomberg) -- As the market’s eyes turn to Italy’s constitutional referendum, the nation’s assets are showing few signs of panic.

Italy’s 10-year bonds posted their best week since July, while its stock index outperformed all of its developed-market peers in the period. Even the euro, which fell to the lowest since March 2015 last month, is bouncing back before Sunday’s vote, which may dictate Prime Minister Matteo Renzi’s political future.

The referendum, which is targeted to overhaul governance and make it easier to pass reforms, has morphed into a confidence vote on Renzi and a barometer on whether the wave of populism in the Western world has taken hold of continental Europe. As the referendum gets closer, however, investors, who sold Italian assets in the wake of Donald Trump’s election victory, are reassessing the likely impact of a ‘‘no’’ vote on financial markets.

“If the market is really concerned we would expect the spread between Italian bonds and German bonds to rise, but we’ve seen this week that actually it’s declined,” said Lutz Karpowitz, a senior currency strategist at Commerzbank AG in Frankfurt. “So this cannot be the case that investors are really concerned.”

Bonds

Italian bonds jumped this week, with 10-year yields tumbling 19 basis points. The extra yield that investors demand for holding Italian debt over German bunds fell to 160 basis points on Friday, the lowest in three weeks. The spread reached 192 basis points on Nov. 28, the widest since June 2015. The European Central Bank is scheduled to announce its latest policy decision on Dec. 8, when officials may extend their asset-purchase program.

Looking at the tightening in yield spreads “it seems that the market has become a little less concerned,” said Martin van Vliet, an interest-rate strategist at ING Groep NV in Amsterdam. “I’m going to wait until what happens and then see what it means for the ECB, because ironically the worse the outcome, the more the ECB will try to positively surprise markets. If we get a “yes” we get a big relief and the ECB might be tempted not to deliver according to market exceptions. So there’s this interplay between the referendum outcome and what the ECB might do.”

Stocks

Italy’s FTSE MIB Index of shares climbed 3.5 percent this week, making it the best-performing developed equity market.

Currency

The euro advanced 0.8 percent against the dollar this week, the biggest gain since the start of November. Thanks to the presence of ECB’s bond-buying plan, some investors said they see the currency, rather than the nation’s bonds, as the best way to play the referendum.

--With assistance from Namitha Jagadeesh To contact the reporter on this story: Anooja Debnath in London at adebnath@bloomberg.net. To contact the editors responsible for this story: David Goodman at dgoodman28@bloomberg.net, Keith Jenkins, Paul Armstrong