Head of Fixed Income Strategy
Summary: Today's selloff in Italian sovereigns will add to the palatability of BTPS because their yields will provide a much-needed source of income to yield-starved investors. This week's 50-year auction showed that the market is not afraid to add on Italian risk to maximize return and build a buffer against rising interest rates globally.
This week, investors participated eagerly in government bonds’ auctions and syndications from Italy, Portugal, France and Spain. It seems that the bad days are over, and investors are lining up to purchase debt which yields have risen just a bunch of basis points. Governments take the opportunity to issue more debt because they know that cost of funding will rise, and demand might soon fade as market volatility picks up.
As a former central banker, Draghi knows the game very well, and it is no coincidence that this morning he announced that it would borrow up to €40 billion more to pay for more furloughs. The immediate market’s reaction shows that more debt carries bad news (chart below). Yet, following this week issuance of new 50-year BTPS, it is clear that the market is ready to pick up more bonds despite the evident deterioration of the country’s debt profile.
Italy is feeding investors seeking coupon income in Europe
This week’s auction results are offering an important takeaway: the market will do anything for anything to get coupon income.
The new 50-year BTPS benchmark has offered that much-needed coupon income. On Wednesday, we saw order books swelling with €64 billion bids, the highest we have seen for long-term government bonds this week. Demand has been extraordinarily high because Italy issued the new bonds offering a yield of 2.15%, one of the highest in the European sovereign space.
At the same time, Italian government bonds have proved remarkably resilient amid the recent selloff in European sovereigns, falling only by 1%. In comparison, peers registered an average loss of 2%. Such resilience can be attributed to the fact that Italian sovereigns carry shorter duration, and that sentiment has improved since Mario Draghi entered in the political landscape.
Buying into BTPS with a 2.15% coupon might seem reasonable in light of rising interest rates globally. What doesn't look reasonable is seeing high demand for other European sovereigns that provide negative returns, thus are more exposed to interest rate risk. Yesterday, demand for the French 10- and 30-year Bonds was solid, however not justifiable in light of the fact that the yield offered was around zero. The French 50-year benchmark with maturity 2072 issued in January has fallen by 15% since issuance as interest rates risk weighs heavily on its duration.
We believe that Italian sovereign bond issuance will continue to strive because of the much higher return that these instruments provide compared to their peers. Still, their intrinsic risk profile will unavoidably rise as the financial sector becomes more dependent on the country’s government bonds, such as the Financial Times has pointed out.
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