“Draghi puts” puts the Italian bond market in trouble


During his eight years as president of the European Central Bank, Mario Draghi has developed an almost legendary ability to control the borrowing costs of the euro zone government. Judging from the calmness of the bond market in the region since he took office in February, investors seem to think he has similar powers as the Italian prime minister.

Italian bond prices pushed up and lowered the cost of borrowing when Draghi transformed from a former central bank governor who was widely regarded as controlling the Eurozone debt crisis a decade ago to a politician. After a brief volatility in recent weeks, as investors become increasingly concerned that the European Central Bank may soon begin to withdraw emergency stimulus measures, Rome’s borrowing costs have returned to their lowest level in a month.

Goldman Sachs analysts referred to the former ECB president’s power over the bond market as “Draghi puts.” “Italian sovereign risk pricing shows people’s confidence in Draghi’s ability to control political risk,” the bank wrote in a report to customers last week.

Investors have expressed support for the Prime Minister’s plan to reform the Italian bureaucracy while spending 205 billion euros in EU recovery funds. Relative to the interest cost of ultra-safe German 10-year bonds, the most important spread paid by Italy for its debt is just over 1 percentage point, not far from the five-year low in February.

James Athey, bond portfolio manager at Aberdeen Standard Investments, said: “There must be a view in the market that Draghi can’t make mistakes and everything he touches will turn into gold.”

Some fund managers are aware of the opportunity to free Italy from decades of low growth and stagnation. They bet that the stability provided by Draghi’s National Unity Alliance provides the ideal backdrop for the reform plan, as Italy has deployed one of the largest shares of the European Union’s 750 billion euro pandemic recovery fund. The government has set up a supervisory agency to supervise cash payments, and has taken measures to streamline bureaucracy and accelerate infrastructure development.

“This is exactly what Italy needs to solve its long-term problems. Insight Investment’s global interest rate director Gareth Colesmith (Gareth Colesmith) said that this is targeted fiscal expenditure for correct reforms. “This is why we are optimistic about Italy. . “

The direction of Italy’s interest rate spread has an impact that transcends national borders. As the largest government bond market in the Eurozone — and one of the most risky markets — Italy has set the tone for the group’s high-risk assets. Fidelity International Investment Director Andrea Iannelli (Andrea Iannelli) said that for now, the “Draghi effect” has helped conceal concerns that Italy’s huge public debt accounts for more than 160% of GDP.

Iannelli thinks this may be too optimistic. Planning is one thing, but deploying billions of dollars of investment could reignite old political conflicts. There are some signs of dissatisfaction among voters. The anti-EU Italian Brotherhood-the only major party that does not support the Draghi coalition-is now ranked second in the country after a steady rise in opinion polls.

“It won’t be smooth sailing,” Iannelli said. “And smooth sailing is what the market has already priced.”

As a technocrat appointed, Draghi is not expected to continue as prime minister after the next election. The alliance’s term must end in 2023, but if Draghi decides to run for the president of Italy, the vote may take place as early as next year.

Chiara Cremonesi, fixed income strategist at UniCredit, said the market may soon start to worry about what will happen after the unified alliance. “Investors are bullish on Draghi, so they are obviously worried about how long his government will last,” she said. She added that UniCredit does not expect to hold a general election in 2022, but the “increase in political noise” may push the spread back to the level of about 1.2 percentage points reached before Draghi took office.

Even without a political outbreak, the relative calm of the market depends on the European Central Bank and its continued support for the market through the 185 million euro pandemic bond purchase program launched by Draghi’s successor Christine Lagarde. The Eurozone bond sell-off in May widened Italy’s interest rate spreads and also raised Germany’s yields. This shows how sensitive the market is to any suggestion to “shrink” net purchases from the current interest rate of 80 billion euros per month.

Since then, a series of ECB officials, including Lagarde, have assured investors that they will continue their efforts at this month’s policy meeting. Investors believe that the European Central Bank will be particularly sensitive to any rise in Italian yields. As long as the former ECB president is still in office, some people are betting that the central bank will be more likely to keep the stimulus measures running.

“As long as they think that Italy is making wise reforms, they will continue to provide support,” Cole Smith said.


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