Fixed Income Headlines: Italy's Turn

Mid Week Bond Update

Fixed Income Headlines: Italy's Turn

Attention now returns to Italy, where coalition politics and the upcoming budget negotiations intersect with EU realities.


Fixed Income Headlines: Italy’s Turn

As the economic challenges of Brazil, Russia, Argentina and Turkey become more familiar, attention now returns to Italy, where the shifting sands of coalition politics confront the need to propose a budget in September. 

The leftist and anti-European Union (EU) factions are so far finding common ground in adding at least about €100 billion to the already steep government debt of €2.3 trillion, which could handily exceed the EU’s 3% deficit target, driving the budget shortfall as high as 5% of the country’s GDP. The new borrowing would be the result of delivering on pre-election promises including minimum incomes, as well as urgently-needed spending increases on infrastructure, brought home by the tragic bridge collapse in Genoa.

Bond investors are reacting predictably, selling Italian debt and driving yields and spreads to levels not seen in over 4 years, and reminding some observers of the dark days of the 2012 European debt crisis. As of August 29, Italy’s 10-year government debt is yielding 3.17%, about 280 basis points (bps) above Germany’s benchmark yield, second only to Greeces’ 373 bp spread.

Add to these concerns the European Central Bank’s plan to back off its ultra-accommodative bond-buying program next year, removing a major buyer from the marketplace just as Italy’s presumed deficit spending gets underway in earnest.

 

On the Rise: U.S. Treasury Curve Steepening (In Some Ranges)

Source: Bloomberg, August 28, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Fretting about the flattening of the U.S. yield curve remains a constant. But not all maturity spreads are falling.  In recent days, the 2 year-10 year (2-10), 2-30, and 5-30 spreads have widened slightly. Even the 10-30 spread has been drifting upward slightly since the end of July. And somewhat surprisingly, the 5-30 is now somewhat higher than the 2-10.  

Some of these changes are due to an upward move in the 30-year yields since the close of trading on Friday, August 24th; from 2.958% to as high as 3.038% on August 28th, about an 8 bp pickup. That’s worth noting on its own; the 30-year Treasury is widely understood to reflect expectations of growth and rising prices. If that’s the story behind the 30-year, the 8 bp pickup could be an important counterargument to the current worry about declining growth.

 

On the Slide:  Emerging Market Downdraft

The general downturn in EM bonds has been severe in recent months. The reasons are well understood, and include worries about trade wars, the updraft in the U.S. dollar and the shifting growth dynamics in China.

 

Source: Bloomberg, August 28, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

But in recent weeks, markets have regained their focus on the four most troubled countries: Brazil, Russia, Argentina and Turkey. Each of these so-called BRATs has its own internal economic and political challenges.

It’s worth noting that since the end of Q2, the Bloomberg Barclays (BB) EM Hard Currency Aggregate Bond Index has returned 0.94%, the BB EM Local Currency Government Index fell a slight (0.03%) and the MSCI EM Currency Index fell (1.06%). All three indexes include the four most troublesome emerging market (EM) countries.

This is not to say the asset class has turned the corner.  But it could be wise to reconsider this asset class in the light of its recent history.

 

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