In the second half of May, Italian government bond yields soared by more than one percentage point, reaching levels double those of Spain and one percentage point above Portugal. The correction recorded by the BTP weighs on the quarterly results of the banks, which have suffered a negative impact, manageable but visible, on their own capital.
The real economy is not immune to it: in the coming months, higher interest rates will increase government interest spending and will be reflected in mortgages and loans to companies, taking away the impetus to growth that is already slowing down.
Since the end of May, the yield on ten-year government bonds, as well as the spread over the Bund, has remained substantially stable. Investors seem disoriented: on the one hand, the bellicose declarations on the deficit coming from the M5S-Lega; on the other hand, the reassurances coming from the Ministry of Economy and Finance and, above all, from Minister Giovanni Tria, who confirmed continuity with the budget objectives of the previous governments and suggested that the flat tax and the basic income will be spread over time and amount.
The next institutional steps will determine the performance of the BTPs and, consequently, of the Italian stock market. The DEF (Economics and Finance Document – Stability Programme) will be published on 27 September, in which the fiscal forecasts and strategies for the next few years will be outlined; on 15 October the budget law will be sent to the European Commission, which will provide its opinion by the end of November.
It will be a demanding budget law: around 12 billion euros are needed to avoid the VAT increase inherent in the safeguard clauses. If the government were to dust off the initial hypotheses of a higher deficit, perhaps to seek a clash with the European Commission in an electoral key, government bonds and the Italian market would be put under pressure and, perhaps, the relationship with investors would definitely end compromise.
In reality, the European Commission does not have the right to veto the budget law and, if there are deficit overruns, it can only intervene ex post facto. It is the underwriters who determine the yields of public debt. In addition to the European Central Bank (ECB), which will interrupt its securities purchase operations at the end of the year, there are investors: we need to convince them. 70% are Italian – families, banks, insurance companies, pension funds, etc. – and only 30% foreign. Finally, by the end of the year the budget law must be approved in Parliament, to then pass to the scrutiny of the President of the Republic.
These are not formal steps: the President has the duty to send it back to the Chambers if it does not comply with the Constitution which, since 2012, provides in Article 81 for compliance with a balanced budget net of cyclical components. So what to do on the Italian market? As far as government bonds are concerned, we are waiting to have greater visibility on the budget law; should there be further episodes of volatility, such as last May 29, targeted purchases on short maturities could be considered. On the Italian stock market, traditionally very exposed to the banking sector and therefore sensitive to the performance of BTPs, we maintain an underweight due to the impact of higher yields on the economy and uncertainty about fiscal policy.
°°° The author is Chief Investment AM of UBS
