Last Year's Nightmare, This Year's Boom: Markets Ignore Italy Risk

By FeaturesDow Jones Newswires

Last year, the coming Italian election in March was seen by some as having the potential to split apart the eurozone.

Now, with just five weeks to go, not so much.

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Many Italian assets have rallied and outperformed European peers, thanks in part to the country's expanding economy and shrinking unemployment. In addition, the perceived threat from antiestablishment politicians has eased. All of which has soothed investor concern as the vote approaches, a trend that isn't uncommon to elections in the country.

"Every time you have an election in Italy, people say 'whoa, there's a lot of political instability', but every time it's a nonevent," said Marie-Anne Allier, head of euro fixed income at Amundi, Europe's largest fund-management firm.

In late 2016, concern that Italians would reject constitutional reform in a referendum provoked widespread concern. Italians did reject it, but the selloff that followed that was short-lived.

"Everyone who sells Italy because of an Italian election loses money," she added.

This year, Italy's flagship stock index is up 7.5%, compared with 3.3% for the Euro Stoxx index of eurozone equities. That puts the FTSE MIB ahead of its peers in Germany, France and Spain.

And while Italy's recovery has been slow by the standards of its eurozone peers, the latest GDP data showed a 1.7% expansion in the year to September 2017, the fastest rise since 2011. Unemployment, at 10.8%, has now declined to its lowest level since 2012. Italian banks have made attempts to clean up balance sheets weighed down by bad loans, and recapitalizations and liquidations have helped to lift the sector.

"Accelerating GDP growth, rising sentiment, reducing banking risks and a positive rating cycle currently overshadow still-elevated Italian political risks," said Giada Giani, an economist at Citigroup in a recent research note.

Ahead of key elections in the Netherlands, France and Germany, political risk dominated discussions among investors for much of last year, even as regional economies showed signs of improvement.

Three-month euro risk reversals -- derivatives that measure the premium investors demand to hold euros for a quarter -- showed that investors feared a sudden drop in the euro's value.

But now, those risk reversals indicate that investors don't currently require compensation to hold euros. European stocks still lag U.S. peers, but they still have had a good start to the year, Italian markets in particular.

The spread between Italian and German sovereign bonds -- a common indicator of the additional default risk associated with Rome -- has declined in the new year.

Italy's 10-year bonds offer a yield 1.4 percentage points higher than Germany's, around the least in a year. As recently as April 2017, those yields were 2.1 percentage points higher.

Despite the gains, investors like Amundi's Ms. Allier still see value in the country's government debt. Italy's 10-year government bonds offer a yield of around 2%, while French and German equivalents offer less than 1%.

While European shares lagged rallying stocks in the U.S. and Asia, investors were more bearish on Italy than any other market except the U.K. as recently as July, according to Bank of America Merrill Lynch surveys. Now, the same surveys show investor sentiment has roughly balanced.

In equities, investors were more bearish on Italy than any other market except the U.K. as recently as July, according to Bank of America Merrill Lynch surveys. Now, the same surveys show investor sentiment roughly balanced.

Aside from bright economics, concerns over Italian political risk have also faded as the local populist parties that prompted it take a softer line.

The country's most prominent populist party, the 5 Star Movement, has backpedaled on demands for a referendum on the country's membership of the eurozone. The party's candidate for prime minister, Luigi Di Maio, now says such a vote would be a last resort.

Betting markets and analysts suggest that the center-right coalition put together by former Prime Minister Silvio Berlusconi will likely emerge with most seats after the March election. The anti-immigration and euroskeptic Northern League opted to join Mr. Berlusconi's coalition.

"While Mr. Berlusconi is a very colorful character I don't think he's going to upset too many apple carts," said Chris Hiorns, fund manager at Edentree Investment Management.

"The big thing that happened is that people feared Five Star and Lega Nord would get together and somehow push through a governing coalition," he added. "That scenario really looks unlikely."

To be sure, many analysts and investors see longer-term risks in the Italian economy. Growth is still slow and with the country's stock of nonperforming loans still high, the banking system is weaker than most other parts of Europe.

Also, Italy's comparatively lukewarm support for the euro, which fanned investor's concerns last year, hasn't got any better. Only 59% of Italians say they are in favor of a single European currency, according to European Commission survey data, below Germany's 81%, France's 71% or even Greece's 66%.

Goldman Sachs still believes that assets could still move to account for the risks surrounding the election in the weeks to come.

"It seems to us that the market is complacent," said Silvia Ardagna, economist at Goldman Sachs in a recent research note. Ms. Ardagna noted that most market moves ahead of European elections often come during the last two to three weeks of the campaign.

Write to Mike Bird at

(END) Dow Jones Newswires

January 31, 2018 06:36 ET (11:36 GMT)

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