Italian bond markets were hit hard in heavy trading volumes on Monday as investors prepared for heightened political uncertainty while the nascent coalition between populist parties strived to form a government.
Luigi Di Maio, the leader of the anti-establishment Five Star Movement, and Matteo Salvini, the head of the far-right League, were due to meet the Italian president on Monday to secure his approval for their alliance.
The party leaders proposed Giuseppe Conte, a little-known 53-year-old professor who specialises in public administration law and has hardly any political experience, as prime minister for the alliance.
The hectic trading volumes on Italian debt and equity markets seen late last week continued on Monday, as investors reacted to the prospect of the anti-euro parties taking political power.
Nicola Mai, sovereign credit analyst at asset manager Pimco, said the coming weeks would see a stand-off between Italian politicians and the markets, as the new government tested investors' tolerance for its policies.
The market sell-off had “obviously been a factor” in the populist parties’ retreat from some of the more radical policies set out in a draft coalition agreement leaked last week, which sparked the continuing bout of market turbulence, he said.
“The key constraint is going to be the market, which will react to how confrontational the government will be with the EU,” Mr Mai said. “There could be some volatility but as reality hits their promises will have to be reined in.”
Ten-year bond yield
The 10-year bond yield rose 20 basis points to 2.42 per cent, taking its total rise in the past two weeks to 64 basis points. The premium over equivalent German debt – a widely watched indicator of euro-zone political stress – hit 189 basis points, its highest level since last June.
Rating agency Fitch warned on Monday that the populist coalition posed a risk to Italy's credit profile.
Political risk had been "a key factor in our downgrade" of Italy to BBB last year, Fitch said in a statement that highlighted "fiscal loosening and potential damage to confidence" as worth watching in the coming months.
"This is blood-letting now," said James Athey, senior investment manager at Aberdeen Standard Investments, who has been short selling Italian debt since February.
Milan was one of Europe's most active equities markets on Monday, with more than €4.5 billion of Italy-listed shares trading, according to data from Cboe Global Markets Europe.
After opening more than 2 per cent lower, the market pared losses and closed with a drop of 1.5 per cent, in the process slipping behind France's CAC 40 as the best-performing European equity benchmark for 2018. However, Monday's losses come as several stocks went ex-dividend in Milan, including Intesa Sanpaolo, Eni, A2A and Italgas. Italian stocks remain up 6 per cent this year.
Investors sold banks, which are highly exposed to Italian sovereign bonds, but exporters such as Fiat Chrysler and oil and gas driller Saipem were sought as share trading volume rose to nearly double the level seen in London. Most activity was transacted on the exchange, indicating that many large institutional investors had sold their holdings in the opening auction.
Daily volumes
Average daily volumes for Italian 10-year government bonds have risen from €490 million in April to €648 million to date in May, according to Trax, a bond data provider owned by MarketAxess. Its data cover slightly less than two-thirds of the market.
Tim Haywood, investment director at GAM, said: "Shorting [Italian] bonds still looks like a better strategic – if not immediately tactical – path than going long."
But not all investors agreed.
Nick Gartside, fixed-income chief investment officer at JPMorgan Asset Management, said, "we are in the buy zone", as pricing "may well go a little wider from here. But let's take a step back: political risk is nothing new in Europe or in Italy."
The “pretty brutal move” could be due to investors’ pre-arranged orders to sell when prices reach a certain level, he suggested – a tactic known as being “stopped out” – while the political turbulence offered “a more attractive entry level” at which investors could buy into the market. – Copyright The Financial Times Limited 2018
