With Italy facing difficulties in both the long term and short term, Lynch believes it likely the country will see its agency ratings downgraded, meaning that when the government’s bonds are used in the financial system, the person receiving the Italian bonds will then have to apply a higher haircut, said Lynch, co-manager of the Kames Absolute Return Bond Constrained Fund.
Investors can offset this against France, where the status quo could continue if either Emmanuel Macron or Francois Fillon seize election victory, and the possibility of some reforms would be positive for French debt, at least against other European debt markets, Lynch added.
However a win for Marine Le Pen, the Front National candidate in France with a focus on anti-immigrant and anti-EU rhetoric, could spark a new euro crisis, according to Kames fixed income specialist Adrian Hull.
While Le Pen would signal a “big risk” for France on almost every front, the weakness of French bonds could be beneficial for gilts, Hull said. “My simple solution would be to buy German government bonds because I know everyone will want them in a crisis”.
The election of Le Pen, both Hull and Lynch agree, would spark fears of the total breakdown of the EU, and in the event it would be Italy who would lose out as one of the weakest links in the system.
Lynch said: “Ultimately, when the market has to price an increase in such an outcome it should be much worse for Italy than France because of its current weakness. Italy’s debt dynamics are in a worse state by far than France’s, and in the event of an EU breakdown the market would seek out the weakest links in the system (the periphery and Italy) and focus their attentions on them.
“As such, we think regardless of which scenario does emerge, it is more likely France can outperform Italy, and our focus is on the 10-year segment of the market.”
