Italian government bonds and equities have had an overdose of political risk lately and volatility has increased markedly. The race for the White House is coming on the top of the high uncertainty brought about by the constitutional referendum on December 4. Italian assets are hoping for the best possible “risk on” scenarios in the US, no matter who wins the elections for the White House.
A victory by Hillary Clinton could mean business as usual: and this is reassuring in the markets but it holds modest growth potential in case of a “hung Parliament” or Congress dominated by Republicans in the Senate and in the House of Representatives.
In the short term a Clinton victory would trigger a rally in the equity markets and a minor sell-off in US Treasuries and German Bunds, driving yields up as expectations of a Federal Reserve rate hike would rise. Italian BTPs would be favored by this growing appetite for riskier assets and prices on Italian government bonds could go up and yields down for a short while: this is exactly what happened yesterday.
Yesterday, news that Clinton was slightly ahead of Donald Trump and that the FBI was dropping the eventuality of criminal charges against her on the “email affair” drove Treasuries and Bund yields up by a few basis points and BTP 10-year yield down by 3 basis points to 1.71%.
The rally in Italian BTPs would however be short lived, as the uncertainty over the result of the referendum still looms (a “no” vote victory could increase political instability, a deadlock to structural reforms and lower growth potential, according to the markets).
If Trump were to go to the White House, BTPs and Italian stocks would initially be hit by a risk-off mood. However on the medium-to-long term investors holding Italian assets are hoping for the best of all possible scenarios with Trump, that is, a boost to US potential growth that would benefit Italy in all ways.
That is to say, markets hope for a Trump administration that would be able to deliver its very business-friendly agenda, with wide-ranging tax cuts, major public investments, liberalization and deregulation (no protectionism, no walls, no bizarre foreign policy).
Italy is the biggest issuer of public debt in the euro area, its economic growth is well below Europe’s average and the Italian equity market is dominated by one of the shakiest sectors, bank stocks. This makes Italy quite vulnerable to external and internal shocks and nowadays the shocks are very political.
On the international front, the US presidential elections are adding volatility: Italy’s bonds are not safe haven, they go under the category of risky assets, which means that their prices go down with “risk off”and move up with “risk on.”
Marc Ostwald, strategist and economist at ADM Investor Services International Limited, foresees this scenario for BTPs: upside on a Clinton victory looks to be quite limited, BTPs could get as low as 1.60 in 10-year terms, but assuming 10-year US Treasury yields would head towards 1.90/2.00; on a Trump victory, BTPs are likely to retest the 1.77 high, and then it is a question of how thinly sponsored markets are, but 1.90 should cap any move.
Ciaran O’Hagan, fixed income strategist of Société Générale, says that “if Trump wins, markets will be risk off. Treasuries and Bunds will rally. Over the following weeks, I think Bunds will rally more than Treasuries. BTPs won't rally. So we will see some spread widening.”
Mizuho fixed income experts forecast that a clear Trump victory would cause 10-year Bunds to rally up to 0% in yields terms (they are yielding now 0.15%) whilst Italian 10-year BTPs would register a modest move up (about 0.03%): most of the impact would be on the Germany-Italy spread widening up to 18bp in the hours following the results, according to Antoine Bouvet, rates strategist at Mizuho. A Clinton victory would according to this estimate cause 10-year Bund yields to rise up to 0.22%.
John Raymond, banking analyst for Creditsights, thinks that “ if Clinton wins, it probably means broad stability rather than a big bounce upwards. So I would put the Trump downside on bank stocks bigger than the Clinton upside, it would just be the knock-on effects from any general sell-off” but also the rise of protest votes in politics would shed a shadow on the Italian referendum.
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