Assessment: Italy's Bond Market on Smooth Course with Potential Storms Ahead in Summer

21 Dec, 2023

Assessment: Italy's Bond Market on Smooth Course with Potential Storms Ahead in Summer

Analysts project a promising start for Italian government bonds in the initial half of 2024, building upon a stellar 2023. However, potential issues may emerge by June, connected to political shifts and the European Central Bank's forthcoming moves.

Italy's colossal 2.4 trillion euro ($2.6 trillion) public debt, a major player in global government bond markets, has long posed concerns for the stability of the 20-nation currency bloc.

Despite worries compounded by a series of ECB rate hikes aimed at combatting inflation, Italian bonds attracted robust demand throughout 2023, culminating in a high note at year-end. Rome defied expectations by weathering critical reviews from credit rating agencies.

The gap between Italian 10-year BTP yields and safer German Bunds recently hit its lowest level since late August, albeit still considerably wider than other Eurozone nations. This disparity signifies lingering market caution toward Italy's significant debt, around 140% of the country's national output.

Bruno Rovelli, Chief Investment Strategist at BlackRock Italy, maintains a neutral stance, anticipating potential slight widening of BTP spreads in 2024, yet insufficient to warrant an 'underweight' position. Similarly, Gregorio De Felice, Chief Economist at Intesa Sanpaolo, offers an optimistic outlook, foreseeing a decline in BTP-Bund spreads by year-end.

Unexpectedly, the recent narrowing of Italian spreads contradicted analysts' predictions following the government's deficit-increasing 2024 budget presentation. Rating agencies, including S&P Global, DBRS, Fitch, and Moody's, with an upgraded outlook, have eased concerns, potentially attracting more foreign investment in Italian debt.

Despite a resurgence in interest, foreign holdings of Rome's debt remain lower compared to pre-pandemic levels. Analysts caution that challenges may arise mid-year, driven by the ECB's phasing out of bond purchases, new EU budget regulations, and European Parliament elections.

Fabio Balboni, Senior Economist at HSBC, points to potential difficulties for Italy post-summer concerning the 2025 budget and the impact of the ECB's move to end reinvestment in its Pandemic Emergency Purchase Programme (PEPP).

European Parliament elections in June and EU negotiations to revamp fiscal rules also pose risks. If stringent debt reduction measures are required, Italy might struggle to comply, straining its relationship with Brussels and jeopardizing ECB support.

The Italian Treasury faces the task of finding buyers for a net debt supply of approximately 135 billion euros in 2024, made more challenging as the ECB continues to reduce its bond holdings.

While small domestic savers are anticipated to be key buyers, analysts foresee foreign investors potentially increasing their subscriptions. Italian retail investors, who played a significant role in 2023, are expected to maintain their presence in 2024, albeit slightly reduced compared to the previous year.