Sunday, August 19News That Matters

Selloff of Italian Debt Highlights Concerns Over Politics, Banks


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A recent selloff in government bonds in Italy has highlighted renewed investor concern over the politics and banks of a country that routinely sparks regional jitters.

The selling started on Thursday after local media reported tensions in the government over a preliminary budget meeting. Italian banks have also reported results this week that show a fall in the value of their government bondholdings, which investors fear will hit their capital ratios.

In May, concern over Italy’s antiestablishment government sparked a selloff in the country’s government bonds that rattled markets around the world. Then, the country’s two-year bonds saw their worst trading day since records began in 1989.

On Friday, yields on the country’s 10-year note moved above 3% on Friday before falling back to 2.921%. That was up from 2.784% on Wednesday. The two-year bond yield rose to 1.119%, trading near its highest level since June before falling back down to 0.973%. Bond yields move inversely to prices.

The moves have failed to spark a broader selloff in Europe, and investors said the size of the shift in Italy may have been exacerbated by light, summer-holiday trading volumes. But investors say that concerns have never gone away about Italy, which has one of the world’s largest debt piles and a coalition government that has talked of lowering taxes and increasing spending.

Italy’s coalition government has agreed on an ambitious economic agenda that includes both heavy tax cuts and higher welfare spending.

Italy’s coalition government has agreed on an ambitious economic agenda that includes both heavy tax cuts and higher welfare spending.


Photo:

Luca Bruno/Associated Press

“The market is still very nervous about Italy,” said

Lyn Graham-Taylor,

rates strategist at Rabobank. “The budget developments caught people unaware.”

Société Générale strategists on Thursday reversed a recommendation to buy Italian debt that they have held since May.

“The thing to focus on is the government contract, which is to cut taxes and increase spending,” said

James Athey,

senior investment manager at Aberdeen Standard Investments.

Mr. Athey pointed out that the European Central Bank is also winding down its bond-buying program. That bond buying has been credited with propping up debt markets for Europe’s weaker southern economies.

“All that is a pretty toxic mix,” said Mr. Athey, who has been short Italian debt since February.

The coalition government’s two parties have agreed on an ambitious economic agenda that includes both heavy tax cuts, advocated by the far-right League party, and higher welfare spending, pushed by the 5 Star Movement. Political commentators say the two parties could clash during budget talks, given the government may not be able to afford to implement their plans without hurting Italian bonds and coming into conflict with the European Union.

The government is due to meet Friday.

Adding to the negative risk sentiment was a selloff in some financial institutions in Italy, home to a banking sector that has caused investors’ repeated concerns for many years.

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Turmoil in Italian politics has sent shock waves through financial markets in moves reminiscent of the eurozone crisis. WSJ markets reporter Ben Eisen answers questions about the latest Italian financial crisis.

Shares of

Banca Monte dei Paschi di Siena

SpA were down 3.15% Friday after a fall in the value of its bond portfolio hit one measure of its capital buffers. MPS Common Equity Tier 1 ratio dropped to 13% at the end of the second quarter, from 14.4% at the end of March.

Poste Italiane
,

a postal service that has a large insurance business, also sold off after solvency ratios dropped.

“Banks are unveiling in their last earnings reports the negative effect of the political tensions at the end of May,” said

Vincenzo Longo,

a Milan-based strategist at IG Markets. “Investors seem to be speculating that banks going forward won’t be willing to absorb the bonds the ECB won’t any longer buy, and that foreign investors may sell due to likely government tensions in the next months.”

Investors have long worried about a so-called doom loop, in which Italian banks laden with their government’s debt are sucked into a downward spiral as their home economy deteriorates, which then further weighs on the country’s business.

In recent years, Italy’s chronically unprofitable lenders have been restructuring and shedding bad loans. Fragile investor confidence in the turnaround has been dented by the latest political upheaval.

The Italian jitters on Friday lifted demand for haven bonds, such as U.S. government debt. Yields on 10-year U.S. Treasurys fell to 2.979% from 2.986% on Thursday.

Still, some observers remain upbeat about Italian bonds.

Laurence Mutkin,

global head of G-10 rates strategy at

BNP Paribas
,

said that while the country’s debt load is high, the cost of servicing that debt hasn’t been lower since monetary union in 1999. That’s because borrowing costs have been historically low across Europe for several years.

“And the average maturity of the debt has been lengthening,” he said.

—Giovanni Legorano contributed to this article.

Write to Georgi Kantchev at georgi.kantchev@wsj.com

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