Italy’s Bonds Sound the All-Clear Minutes After Coalition Formed

(Bloomberg) --

Within an hour of Prime Minister-designate Giuseppe Conte being granted a mandate to form a coalition, Italy locked in record-low borrowing costs for the next 10 years at a bond auction.

Should he succeed in pulling together a new government, it would mark a brightening outlook for Italy’s embattled investors ahead of fresh budget negotiations with the European Union this fall.

“What we are now seeing is a virtuous circle,” Holger Schmieding told Bloomberg Television Thursday. “Bond yields are falling, which in turn means Italy has more fiscal space, which then reduces the risk of a big confrontation with Brussels that could spook markets.”

Italy’s bonds have surged this week as the Five Star Movement and Democratic Party looked set to form an alliance that although may be fragile, will be less hostile toward the EU. Ten-year yields dropped below 1% for the first time on record, significantly lowering borrowing costs for the nation and easing the pressure on its burgeoning fiscal deficit.

It’s Go With the Flow for Italian Bonds as Yields Get Crushed

The agreement also locks the leader of the far-right League, Matteo Salvini, out of government by postponing the possibility of fresh elections in which the party would likely gain a majority. Salvini has frequently locked horns with EU officials and pledged to bring tax cuts, which threatened to push the deficit through the bloc’s limits.

Full Allotment

The euro area’s third-biggest economy sold its full allotment of 6.25 billion euros ($6.9 billion) of securities. While pricing was weak, it was distorted by a surge in demand going into the auction, according to ING Groep NV. The decline in yields could save the Treasury more than 1% of gross domestic product on an annual basis, said Banque Pictet & Cie.

“The market jumped into the auction so in reality the results are healthy,” said Antoine Bouvet, a senior rates strategist at ING. “If the market takes a very optimistic view on the prospects for the current coalition, 10-year Italy yields could reach 0.60%.”

Democratic Party leader Nicola Zingaretti was quick to highlight the savings for the government from the lower auction yields. “That will now go into the pockets of Italians,” he wrote in a post on Facebook.

Ten-year yields fell eight basis points after touching a record low 0.92%, with the spread over those on German securities at 166 basis points, the lowest level since the forming of the previous coalition in May last year. The drop in yields lifted shares of Italian banks, with Banca Monte dei Paschi di Siena SpA jumping 13%. The FTSE MIB Index is on track for its biggest weekly advance since February.

Budget Deficit

Conte has until next week to forge a coalition that would avert the possibility of fresh elections. The new Five Star-PD government will seek to keep Italy’s 2020 budget deficit within EU limits, according to officials who asked not to be named discussing confidential plans, but any agreement is likely to be a shaky one given they have few issues that unite them.

Even those who have long been bearish on Italian debt are showing a change of heart as the new coalition nears fruition. James Athey, a money manager at Aberdeen Standard Investments, was shorting the country’s bonds for much of the past 18 months, but is now buying higher-yielding longer-dated notes versus their short-dated peers, known as a curve flattening trade.

“Whatever you think about the longevity of this potential coalition that we’re seeing at the moment, it’s certainly more centrist and less scary looking with respect to budgetary policy,” Athey said. “The stars are somewhat aligned at the moment.”

--With assistance from James Hirai, Namitha Jagadeesh, Alessandro Speciale, Phil Serafino and John Follain.

To contact the reporter on this story: John Ainger in London at jainger@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Michael Hunter, Neil Chatterjee

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