Italy Outlook Darkens as Politics Skews From Orthodox Thinking
2018-10-07 11:00:00.0 GMT
By Tanvir Sandhu
(Bloomberg) -- Dark clouds are looming on Italy’s horizon
as the populist government’s budget deficit appears to be on a
collision course with the European Union as the coalition works
to square the circle with underlying growth assumptions.
Increased friction from both sides raises the risk of
contagion which has so far been largely contained to Italian
assets. Markets are trading on fiscal and ratings concerns
rather than redenomination fears, and tentative signs of
compromise by Italy’s government regarding the trajectory for
its deficit path reduces the risk of escalation.
Medium-term debt sustainability concerns with risks of a
hefty increase of the debt-to-GDP ratio leaves a slant to using
any relief in Italian bond markets to reduce exposure and
maintain positive convex hedges.
* The limited response of German 2-year swap spreads, a popular
hedge against Italian risks, to the 10-year BTP/Bund spread
widening to 300bps highlights the low sensitivities of European
assets and current idiosyncratic nature of Italy’s issues
* European equity volatility barely reacted to BTP sell-off
outside FTSEMIB, with SX5E ATM 3-month implied vol at 8th-
percentile of 10-year range, volatility skew has barely moved
and FTSEMIB/SX5E 1-month ATM vol ratio close to record highs
* Another popular hedge against Italian risk is the relative
value between high and low coupon BTPs, where high-coupon bonds
that trade above par sharply underperform as markets price
higher default probabilities (as investors stand to lose more on
those higher priced bonds)
* Long low-coupon vs high-coupon BTPs performance has been less
pronounced during recent spread widening compared with the
pronounced sell-off in May driven by heightened redenomination
fears
* NOTE: Tanvir Sandhu is a global interest-rate and derivatives
strategist who writes for Bloomberg. The observations he makes
are his own and are not intended as investment advice
To contact the reporter on this story:
Tanvir Sandhu in London at tsandhu17@bloomberg.net
To contact the editors responsible for this story:
Ven Ram at vram1@bloomberg.net
Keith Jenkins
2018-10-07 11:00:00.0 GMT
By Tanvir Sandhu
(Bloomberg) -- Dark clouds are looming on Italy’s horizon
as the populist government’s budget deficit appears to be on a
collision course with the European Union as the coalition works
to square the circle with underlying growth assumptions.
Increased friction from both sides raises the risk of
contagion which has so far been largely contained to Italian
assets. Markets are trading on fiscal and ratings concerns
rather than redenomination fears, and tentative signs of
compromise by Italy’s government regarding the trajectory for
its deficit path reduces the risk of escalation.
Medium-term debt sustainability concerns with risks of a
hefty increase of the debt-to-GDP ratio leaves a slant to using
any relief in Italian bond markets to reduce exposure and
maintain positive convex hedges.
* The limited response of German 2-year swap spreads, a popular
hedge against Italian risks, to the 10-year BTP/Bund spread
widening to 300bps highlights the low sensitivities of European
assets and current idiosyncratic nature of Italy’s issues
* European equity volatility barely reacted to BTP sell-off
outside FTSEMIB, with SX5E ATM 3-month implied vol at 8th-
percentile of 10-year range, volatility skew has barely moved
and FTSEMIB/SX5E 1-month ATM vol ratio close to record highs
* Another popular hedge against Italian risk is the relative
value between high and low coupon BTPs, where high-coupon bonds
that trade above par sharply underperform as markets price
higher default probabilities (as investors stand to lose more on
those higher priced bonds)
* Long low-coupon vs high-coupon BTPs performance has been less
pronounced during recent spread widening compared with the
pronounced sell-off in May driven by heightened redenomination
fears
* NOTE: Tanvir Sandhu is a global interest-rate and derivatives
strategist who writes for Bloomberg. The observations he makes
are his own and are not intended as investment advice
To contact the reporter on this story:
Tanvir Sandhu in London at tsandhu17@bloomberg.net
To contact the editors responsible for this story:
Ven Ram at vram1@bloomberg.net
Keith Jenkins