A bargain or a warning sign?
In a video interview Franklin Templeton’s Zahn had with Expert Investor about a year ago, he said the “true risk premium” of Italian government bonds versus Bunds was about 60 basis points. At the moment though, the spread is more than 200 bps. This suggests Italian govvies should now be attractively priced.
“There certainly is a possibility that Italian bonds won’t lose you money over the next 12 to 18 months, even if Renzi loses the referendum,” says Zahn, who believes the Italian prime minister will carry on as a ‘lame duck’ even after losing the vote. “None of the political parties in Italy want to go to the polls immediately, so he could stay on until the end of this term in 2018 depending on the margin he loses the vote by.”
Draghi to the rescue
Though such an outcome would probably not do much to stop bond yields from rising further as it would lead to a prolonged period of political uncertainty, there is of course another force to be reckoned with: the ECB.
The spike in bond yields since the US general election has made the case for more ECB stimulus more compelling. Mario Draghi’s repeated hints that the ECB’s asset purchasing programme will be extended beyond March 2017, in combination with his long-standing promise he will do everything to save the euro if things really start looking as serious as they did back in 2011/12, will likely be beneficial for Eurozone government bonds. And those bonds that are under pressure today are likely to benefit disproportionally from Draghi dovishness.
Investor’s eyes are therefore not only on the Italian referendum on 4 December. “The ECB meeting on 8 December is also very important,” says Zahn. The fall-out after a no-vote in Italy may therefore well be just as limited as was the case after Brexit and the US elections.
But it would only add more political risk to an increasingly poisonous cocktail. The ECB may help markets to ride it out until 2018, but this is the year both Matteo Renzi’s and Mario Draghi’s terms expire. Bond spreads may rise further or temporarily contract a bit over the next 18 months thanks to ECB action, political uncertainty will almost certainly rise further.
