Banks are Italy’s Achilles heel in battle to lift feeble sentiment
Coalition’s budget plans have intensified volatile trading for stocks and bonds
As Amazon and Apple have helped propel Wall Street higher, European equities have languished. Dominated by sluggish bank stocks, they have been out of favour for months.
The region’s stock markets face multiple challenges, from the economic risks around Brexit to rising anti-EU sentiment to the winding down of the European Central Bank’s quantitative easing programme.
But, for now, it is hard for investors to look beyond Italy. The anti-EU stance of the country’s coalition government, made up of the populist Five Star Movement and the League, has helped drive bond yields sharply higher and weighed on the country’s stock market since May.
“Sentiment on the region remains feeble,” said Ritu Vohora, equities director at M&G.
In a sign of how sensitive investors are towards the eurozone’s third-largest economy, soothing words this week from deputy prime minister Matteo Salvini over the government’s budget plans have been enough to trigger a sharp rally in Italian bonds and send shares of the country’s banks higher over the past few days.
Investors’ anxiety in recent weeks has been driven by the prospect that the coalition’s debut budget extends Italy’s fiscal deficit, setting up a clash with both Brussels and the country’s finance minister Giovanni Tria, who is widely seen as a moderating force within the government.
Camille De Courcel, an interest rate strategist at BNP Paribas, said Italy’s budget plan would leave its deficit closer to 2 per cent of gross domestic product than 3 per cent.
The spread between Italian bond yields over German, the benchmark for the eurozone, remains near the highest level since 2014.
“If we do see that 2 per cent number, we would expect some compression in Italian spreads,” said Ms de Courcel.
Whether Rome can craft a budget that keeps spending under control matters to Italy’s banks, given their close links and exposure to Italian government debt.
The fall in Italian bank shares since late April is closely connected to its stressed government debt, said Paola Toschi, global market strategist at JPMorgan, because about 18 per cent of the country’s sovereign bonds are held by its lenders.
“This creates a direct relationship between how the government bonds move and how the Italian banks perform in the equity markets,” said Ms Toschi.
Italian government bonds have suffered a sharp sell-off this year and last week the government paid the most in four years to raise debt in a €7.75bn bond sale.
Salvatore Rossi, the Bank of Italy’s deputy governor, warned last week that the “vicious link” between sovereigns and banks had not been cut.
At the same time, a lacklustre Italian economy lacking fiscal stimulus will do little to help Italy’s banks reduce their large burden of non-performing loans.
The fate of bank shares helps shape that of the wider Italian stock market as financials account for a fifth of the weighting of Milan’s FTSE MIB index, according to Bloomberg data.
Of the FTSE MIB’s 10 worst-performing stocks since the start of May, five are banks. In turn, the MIB is 4.4 per cent lower over the same period.
“Italian banks look most vulnerable,” said Ms Vohora, “and by comparison with Brexit and UK domestic banks, they look to suffer a similar fate.”
The weakness in emerging markets is also a headwind for some lenders. Italy’s biggest bank, UniCredit, has been caught up in Ankara’s economic firestorm thanks to its 40.9 per cent ownership of Turkish bank Yapi Kredi. Shares in the Italian lender are down 26 per cent since the start of May.
Yet some analysts reckon financials are now too cheap to ignore. Ms Vohora said that Italy’s biggest lender, Intesa Sanpaolo, at a deep discount and an 8 per cent yield, had a “compelling valuation”.
Ms Toschi of JPMorgan said “investors were much more captured by the negative headlines”, and “we are pretty optimistic”.
Whether EM’s woes deepen or not, Italy faces the challenge of selling some €63bn in fresh debt this year to meet its remaining annual financing needs at a time when the ECB is winding down its bond purchases.
Indeed, last month Giancarlo Giorgetti, the Italian cabinet undersecretary, indicated that he would like the ECB to continue buying fresh bonds. But at the same time, the ECB maintaining low interest rates remains a major barrier to banks’ profitability.
“What Italian banks are missing is top-line growth,” said Claudia Panseri, European equity strategist at UBS Wealth Management, which recommends that investors cut back their exposure to financials across the eurozone.
For Ms de Courcel, “[bond] issuance returning to the market and declining QE flows” means yields on Italian debt will rise between now and the end of the year.
It amounts to a testing backdrop for the government’s first budget as well as the shareholders in the country’s banks.