Italy Is the Darling of the Bond World for 2021
(Bloomberg) -- As European bond strategists draw up their top trades for 2021, one popular theme rises above the rest: load up on Italy’s long-dated debt.
Commerzbank AG, JPMorgan Chase & Co., HSBC Holdings Plc and UBS Group AG are targeting a continued decline in Italy’s 10-year yield premium over bunds, while Deutsche Bank AG prefers positioning for a flatter bond curve relative to its German equivalent. Robeco Institutional Asset Management is opting for the country’s 50-year notes.
Italian bonds pay the euro area’s highest investment-grade yields, and their allure is burnished by the drying up of fixed-income returns across developed markets -- more than a quarter of the world’s debt now yields less than 0%. Even rates in other peripheral European nations such as Portugal and Spain have turned negative, with dwindling debt returns forcing some fixed-income investors to seek better prospects in other assets, such as currencies.
Italy’s assets have been the flashpoint for European financial risk in recent years due to shaky domestic politics. The current wave of investor optimism toward the debt is seen as a vote of confidence for the euro area itself. Global faith in the monetary union got a major boost this year after member nations overcame differences for a groundbreaking joint fiscal plan to fund the economic recovery from the coronavirus crisis.
Italy is already the euro area’s best-performing debt market this year, with yields hitting record lows, enjoying the support from the European Central Bank’s 1.85-trillion-euro ($2.3 trillion) pandemic asset-purchase program. The nation will also be one of the top beneficiaries of the European Union’s proposed recovery fund.
And as new, faster-spreading strains of the coronavirus fuel a flight of capital from riskier assets and drive down yields in top-rated debt markets such as the U.S. and Germany, Italian rates are even more appealing in comparison, according to Futures First analyst Rishi Mishra. Elevated virus concerns also raise the prospect of more ECB stimulus, which is seen supporting the Mediterranean nation’s markets.
“From an Italian perspective, the picture is clear -- if you see a deteriorating situation in terms of Covid, then that gives rise to speculation that the ECB has further work to do, which is supportive of peripheral debt,” said Richard McGuire, head of rates strategy at Rabobank. “And if a post-vaccine recovery looks more assured, then that should underpin fundamental optimism and greater risk appetite, which also suggests buying” Italy’s debt, he said.
The ECB expanded its Pandemic Emergency Purchase Program, or PEPP, by 500 billion euros this month, boosting the prospect of support for Italian debt.
The nation’s bonds have returned 8% this year, the most in Europe and more than double that of Germany, according to Bloomberg Barclays indexes. Yields on the Mediterranean nation’s 10-year debt reached an all-time low of 0.507% last week, compared with a high of 2.99% in March, when the onset of the coronavirus pandemic roiled global markets. The premium on the notes over German bunds has narrowed by 45 basis points this year to 115.
Positioning for a drop in the Italian 10-year yield premium over German bunds is probably the most favored trade for 2021 among fixed-income strategists.
Commerzbank is now calling for that spread -- a key European risk gauge known as “lo spread” -- to narrow to 75 basis points.
Strategists at JPMorgan and ABN Amro Bank NV expect the Italian spread to fall to 80 basis points next year, while HSBC’s Chris Attfield targets a move to 100 basis points. Futures First’s Mishra sees the gap narrowing to 90 basis points.
Commerzbank is the most bullish on the spread, calling it to narrow to 75 basis points -- a level last seen almost 11 years ago.
“The tightening for Italy is justified,” said Jolien van den Ende, a strategist at ABN Amro, citing the role played by the ECB in keeping rates and debt service costs low. “This makes the debt level sustainable on a very high level, in combination with a search for yield.”
Long, Longer, Longest
Others are making an outright play on the nation’s debt. Italy’s longest-dated bonds -- due in 2067 -- offer the euro area’s highest rates, and buying them is the region’s maximum-yield trade, according to Martin van Vliet, a strategist at Robeco Institutional.
Even near a record low, the 1.73% rate on the note is about quadruple that of its French peer and Austria’s century bonds.
While its maturity term is too long to be included in the ECB’s bond-buying remit, “it offers appeal in current circumstances” characterized by ultra-low yields, said Van Vliet. The bond is also less vulnerable to volatility spurred by shifts in risk sentiment because of its maturity period, he added.
Jens Peter Sorensen, chief analyst at Danske Bank A/S, would put his money on buying Italy’s 30-year debt given its relatively high yield, support from the ECB’s bond-buying program and the EU’s recovery fund. Political stability in Rome also adds to the securities’ appeal, he said.
Analysts at Deutsche Bank AG recommend positioning for the Italian yield curve to flatten in relation to its German counterpart.
They suggest buying the nation’s 30-year bonds, which pay the highest rate for the tenor among developed markets, and selling 10-year notes while simultaneously entering an opposite position in German debt -- selling 30-year bunds and buying 10-year ones.
©2020 Bloomberg L.P.