Puzzle of the shrug from markets as populists take power in Italy
The ECB’s buying of Italian debt and an extension of maturities has improved resilience
Five-Star Movement (M5S) leader Luigi Di Maio arrives to address the media after a meeting with Italian President Sergio Mattarella .Photograph: Angelo Carconi/EPA
For years, debt investors have feared a populist government taking power in a large European country.
Now, with a deal likely to be struck in Italy to share power between two parties openly hostile to the euro, investors are not clamouring for the exit.
The arrival of a coalition government in Italy between the Five Star and League parties marks the first time that populist politicians will take hold of a European economy significant enough in size to potentially reignite concerns over the future of the single currency.
One barometer of investor sentiment, Italy’s 10-year bond yield, merely edged higher on Thursday as details of the shape of a new Italian coalition government emerged.
At 1.91 per cent, the benchmark yield remains below the 2.12 per cent peak seen on the day after the country’s inconclusive election in early March.
Italian bank shares have remained stable during the post-election uncertainty although the sector remains burdened by non-performing loans, and lenders have been forced to raise billions of euros in fresh equity to bolster their balance sheets
So why, considering that in 2013 the notion of leaders like the Five Star’s Luigi Di Maio and Matteo Salvini of the League taking power would have sent Brussels politicians into paroxysms of panic, are investors so apparently relaxed?
Luca Cazzulani, deputy head of fixed income strategy at UniCredit, said that any unease about Italian politics may be offset by ongoing bond-buying by the European Central Bank, which has served to suppress yields across the continent.
“The modest reaction in yields so far reflects a mix of structural factors and market conditions which have become supportive for Italian debt,” he said. “Since the beginning of QE, the investor base has changed. About 15 per cent is held by the ECB, which buys and does not sell.”
Another way of measuring investor sentiment involves looking at the additional yield demanded from holding Italian 10-year debt over equivalent German bonds. Investors are currently seeking an extra 136 basis points over 10-year Bunds.
While this is above the low of 114 seen in late April, its less than the 145 basis points seen after the March poll confirmed that populist Eurosceptic parties were the dominant force in Italian politics.
Mr Cazzulani also pointed to the fact that Italy has taken advantage of lower rates to refinance itself at longer maturities, meaning that it is less vulnerable to sudden shifts in investor sentiment forcing it into borrowing at much higher rates.
“The debt itself has become more resilient to shocks because the Italian government has been issuing at longer maturities, increasing the average maturity. As a result, shocks to the yield curve take longer to feed through into a rise in the cost of debt,” he said. “The country can stand a longer shock to the yield curve without endangering debt sustainability.”
Beyond the bond market, many Italy-listed companies are multinationals which do large amounts of their business abroad.
That 2 per cent yield may not be too far off. In March, Mr Salvini attacked the euro as “a mistake” which was “doomed to fail”.
While both he and Mr Di Maio have since somewhat moderated their rhetoric, investors will have to be prepared for the possibility of more outspoken comments from either in the coming months.
If signs emerge that a new government will take a tougher stance on co-operating with Brussels, the market’s current relatively tranquil conditions may become more turbulent.
Lorenzo Codogno, chief economist at LC Macro Advisors, said that further market moves were going to depend on the nature of the deal that the Italian parties strike.
“Some clear boundaries and guarantees” agreed by the new coalition about the policies they would pursue “would do the trick”, Mr Codogno suggested, “and probably moderate the reaction by financial markets”. - Financial Times