With just under a month to go until Italy goes to the polls, fixed income investors appear to be getting jittery as a series of wildcards jeopardise the incumbent’s market-friendly legacy.
‘Italian government bonds have started to underperform against other eurozone countries and the Italian 10-year government bonds now offers a yield of around 2%, which is higher than all other eurozone countries but Greece,’ said Carlo Putti, an investment specialist on M&G’s bond team.
The Italian constitution, which has not traditionally granted winners powerful mandates, faces a series of one-offs which make reading the result even more challenging than usual. These include a move to a first-past-the-post system (see box), the recent political resurrection of former prime minister Silvio Berlusconi and the rise of the populist Five Star Movement.
The poll itself was called by current prime minster Matteo Renzi (pictured) in December 2016 after voters in a national referendum rejected his constitutional changes, including pro-market structural reforms.
But the failure to pass much-needed reforms, and uncertainty brought on by the general election have already been priced into markets, according to Putti, and have not halted a long-term recovery.
‘While the Italian risk perceived by the market – as calculated by the spread of Italian government bonds over German government bonds – remains high relative to other eurozone countries, it is coming down in absolute terms as the eurozone recovery remains on track,’ he said.
M&G remains broadly constructive on eurozone recovery and expresses this view by holding peripheral government bonds – Italy included – as they look cheap compared to corporates.
‘We also have a preference towards longer dated government bonds as the curve appears to be fairly steep in the eurozone,’ added Putti.
The consistent lead taken by the Five Star Movement, which was formed as a broad protest movement against Italy’s legacy parties, has been largely discounted by investors because of its refusal to act as a kingmaker in a collation, said Claudio Ferrarese, bond manager at Fidelity.
He suggested that the party was maturing in ways which may surprise observers who discounted it, and that an increasing willingness to use its electoral clout could end up locking out a possible far-right nationalist coalition which has loosely coalesced around Berlusconi.
‘Our base case remains for a benign, market friendly outcome,’ he said. ‘However, with the elections now just over a month away, I’m going to be closely watching the Five Star Movement as I believe they are more willing to form broad coalitions than the market currently assumes.
‘It should mean that the tail risk of a core-populist led government is less likely and the odds are titled in favour of a more responsible outcome.’
Strong policy stances have been thin on the ground during the run up to the election, said Sandra Holdsworth, co-manager of the Kames Absolute Return Global Bond fund, making it difficult to pinpoint policy positions among the candidates.
‘To date, manifestos and policies from the parties have been fluid; there has been speculation regarding tax rates, attitudes to the EU and the euro from leading figures. However, the next government will almost certainly be a coalition, making voting and analysis difficult,’ Holdsworth explained.
‘The banking sector is tackling its vast non-performing loan problem at a faster pace than expected. Credit ratings too have reversed course, with Italy’s debt being upgraded by Standard & Poors.
‘Demand for Italian debt remains high as evidenced by a recent 20-year deal. The Italian government received orders in excess of €30 billion (£26 billion) for a €9 billion issue, and the current yield spread at which Italian debt trades over German debt remains closer to the lower end of recent ranges than the upper, suggesting that for the moment at least risk is low.’
This election is the first time Italy uses a first-past-the-post system, which analysts expect will lead to a coalition.
There are three probable configurations likely to lead to a winner. There are 14 parties standing in total and any agreement could be fluid. There are also some powerful personalities involved too.
The first is Matteo Renzi, the incumbent prime minister who was elected on a wave of popular support for his reformist platform. Renzi will likely try to form a centre-left coalition around his Democratic Party (PD).
Next up is Silvio Berlusconi, famous for his populist style. He was convicted for tax fraud in 2013 and has been barred from formally taking public office until 2019. He nonetheless exercises considerable power over a major political machine, which could form a coalition around his party, Forza Italia.
Lastly, the broad tent Five Star Movement, headed by comedian Beppe Grillo, may revise its non-cooperation policy and form a coalition. Grillo has previously ruled this out.