Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Italy’s difficult Christmas season might be investors’ present from Santa
Althea Spinozzi
Head of Fixed Income Strategy
Summary: December might be a volatile month for Italian sovereigns. Today Fitch is going to review Italy sovereign debt's rating. Besides, the country has announced that it will continue to issue government bonds throughout the Christmas holiday. It will happen amid low market volatility and the suspension of the ECB's QE debt purchases from mid- December until the beginning of January. We believe that any spike in Italian yields represents an opportunity to enter these securities cheaply to ride the ECB. Italy 30-year BTPs will offer the most significant upside as they might rise as much as 11% by the first half of 2021.
Fitch is due to review the rating for Italian sovereigns today. Although the rating agency is probably going to reaffirm a BBB- with a stable outlook, we believe that that the month ahead will test Italian BTPs' yields.
Traditionally, the bond auctions are cancelled in mid-December until the regular market activity is resumed at the beginning of January. However, as the country needs liquidity to support the economy amid a national lockdown, government bond auctions will take place this year. On the 30th of December, the country has announced it will issue 5- and 10-years BTPs. In this occasion, Italian yields will test the appetite of the market amid limited market liquidity. To make things worse, the ECB’s QE will be suspended from the 17th of December to the 4th of January, unless stated otherwise by the central bank next week.
Since the volatility in March, the spread between BTPs and the Bund has been tightening. The spread between 10-year BTPs and Bunds is close to touching 100bps, a level previously seen in 2015. While we believe that the spread between 10-years BTPs and the Bund will go below 100bps as soon as the first quarter of 2021, we might see some widening this month before the spread will resume its rally.
At this point, it is clear the ECB is looking to expand its bond purchasing program and extend it till the end of next. This will give a boost to all European sovereigns, especially Italian BTPs which are currently trading rich compared to the ones of the periphery.
In term of spread, we will see the sharpest tightening in 30-year sovereigns, with BTPs with maturity 2050 to continue to provide a solid performance at least until next summer.
Since the beginning of the year, 30-years BTPS (IT0005398406) went up by 22% in price. If the spread between 30-year BTPs and Bund falls below 120 bps, reaching 2015 lows, they will go up another 11%. It represents the best opportunity for investors to trade European sovereigns and ride the ECB.
To support BTPs prices is also the stable demand that these securities are receiving from foreign investors. While in March the market has seen foreign investors fleeing Italian sovereigns like it never happened from 2000 until today, foreign demand has rebounded. Suppose foreign demand falls again in December because of the reasons we have mentioned at the beginning of this analysis. In that case, the shift up in yields will represent an opportunity for investors to enter these securities cheaply to benefit from the tightening of the spread between BTPs and Bund caused by expansionary ECB policies. Foreign demand ultimately will pick up and stabilize because of the same reasons.
In conclusion, BTPs are poised to rise in the mid-term. Still, there might be volatility ahead arising from the government bond auctions this month as they come at a time of extremely low liquidity. I believe that a rise in yields will represent a buying opportunity that cannot be ignored.
How to trade Italian BTPs in the Saxo Platform:
Bonds:
You can select among a long list of Italian sovereigns bonds, the maturity you like the most.
Futures:
Euro BTP 10 year: Ticker FBTP, and you can choose the contract expiry
Short-Term Euro BTP: Ticker FBTS, and you can choose the contract expiry
CFD:
10YBTPDEC20
ETF:
Lyxor EuroMTS 10Y Italy BTP Gov UCITS ETF (BTP10:xmil)
Lyxor EuroMTS 1-3Y Italy BTP Govt UCITS ETF (BTP13:xmil)
Lyxor UCITS ETF Daily Leveraged BTP (BTP2L:xmil)
LYXOR UCITS ETF Daily Double Short BTP (BTP2S:xmil)
Lyxor Daily Leveraged BTP UCITS ETF (BTPL:xpar)
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