Italy: A Rather Uneventful Spring

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Includes: DBIT, EWI, FLIY, HEWI
by: Alfonso Ricciardelli
Summary

As the ECB turns dovish, pressure on Italy to comply with the European Commission's fiscal recommendations fades.

Even the current low growth environment in the eurozone - and in Italy in particular - is unlikely to drive Rome to amend its current, mildly expansionary, fiscal stance.

European elections are likely to be a non-event, with market's reaction expected to be muted. This will contribute to shield BTPs from further unwanted investor attention.

On the politics, there is no sign that League leader Matteo Salvini is looking to exchange his current, gullible ally with the more experienced and battle-hardened Forza Italia.

Markets Respite

In the past few months, BTP-Bund spread has tightened almost to a "normal" level, even though it is still far from the ~100 bp spread between Bonos and Bunds - a benchmark that is helpful to understand what's the "extra" level of political risk investors are pricing in.

And political uncertainty is still there, while the country is still unable to introduce structural reforms to increase productivity (the lag with other EU countries is astounding: from 2010 to 2019, Italy's productivity has grown only 0.7%, compared to almost 7% for the eurozone average - which does include Italy).

But, at this point, markets see the Yellow-Green alliance's fiscal position as not too different from coalitions previously ruling in Rome.

BTP pricing seems, therefore, to be by and large correct, and it is actually our sense that some of the short-term risk is not only accounted for but also likely overblown.

For once, European elections are unlikely to constitute a serious driver of Italian asset prices (either way), and might only be accountable for negligible moves in the immediate aftermath.

And specifically, on the fiscal side, our understanding is that, while the European Commission is actively looking at whether to open an Excessive Deficit Procedure, it remains to be seen whether the move will be made anytime soon. And this time around, it will be referred to some of the past numbers (pre-2018), which would greatly reduce the political impact in Rome of such a decision.

Indeed, the "correction" in such specific instance won't be due for a while, assuming the European Council ends up endorsing the Commission's position at the end of the process.

Rome and its politics

The Italian government has officially acknowledged that the country's growth prospects have heavily deteriorated. The 2019 growth downgrade from 1% to 0.1% has had the effect of factually increasing deficit from 2.1% to 2.4%, even when accounting for the 2bn euro buffer provision - set aside by the Italian government.

That is, barring any further worsening of the outlook in the second half of 2019.

But with no urgency to act - again, from what we understand, there will be no immediate request for action - the Italian government will not be under pressure to deliver, and a government crisis in this environment is extremely unlikely.

Conclusion

While most of the positive news is priced-in already on BTPs, our understanding is that there is still a small room for an upside move, especially against some of the investors' negative convictions about EU elections and the supposedly bad relationship between Rome and Brussels.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.