Italy's Got Political Problems, but its Bonds Don't Care
(Bloomberg Gadfly) -- The March 4 Italian elections have produced a lot of drama, an equity-market selloff, and as yet no sign of a government -- but in the bond market, stability should prevail.
Ten-year Italian yields have held close to 2 percent all year so far. Of course, there was always going to be a benefit from the European Central Bank's quantitative easing purchases. But a spike in redemptions is likely to mean extra support.
The ECB's QE holdings include 22.6 billion euros ($27.9 billion) of European government bonds maturing in April, and almost all of these are from Italy and Spain. In addition, the maturities should really be rolling in from its 85 billion-euro Securities Market Program, which bought the debt of bailout countries including Italy and was pretty much closed by Sept. 2012. These will all be reinvested in full.
There are other sources of support, and one of these comes from Italy's closest comparable, Spain. It's been able to shrug off the Catalan independence crisis, and investors are now focused on its stronger economic recovery and the prospect of an upgrade from S&P Global Ratings to A- from its current BBB+ (positive outlook) at its March 23 review.
This helps keep Italian yields in check. The widest Italy has ever been to Spain since the euro crisis is 72 basis points, and now the spread is around 60 basis points.
Then there are the political negotiations. Some of the calm in markets hangs on the fact that President Sergio Mattarella has broad constitutional powers to act as an independent arbiter once Parliament reconvenes on March 23. If there's no new government formed by that time it is likely he will ask the existing caretaker government to continue until a replacement can be agreed. While this would provide some clarity it would still be no great shakes for Italy, which has had 64 governments in the postwar period, several of which have been technocratic administrations.
Recent changes to the electoral rules also, so far, seem to be keeping investors from getting spooked.
The new "Rosatellum" rules, which were adopted in the summer, mean that the way to secure a majority is via pre-arranged coalitions. This favors traditional parties. So, despite winning the most votes, the populist Five Star Movement is at a disadvantage as it refused to join any combination. It's not a foregone conclusion that they're shut out -- anything can happen, and the fact that the party got the most votes means they can't just be pushed to one side.
Still, these new rules make it incredibly difficult for the League, led by Matteo Salvini, to break away from its agreed partner, Silvio Berlusconi's Forza Italia, to form any alliance with Five Star. It's in the interests of the two center-right parties to see if a grand coalition can be formed that excludes Five Star, as new elections run the risk of the populist vote climbing even higher.
It is hard to build a bull case for Italian bonds until a cohesive government is formed. But Spain's recent success in moving on from political fallout does offer that prospect -- as long as the ECB has its back.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
©2018 Bloomberg L.P.