At Tricio a deep understanding of economic cycles and financial market risk considerations is critical to our long-term assessment of potential rewards. Part of this process is looking at charts as a gauge to investor sentiment. At the moment, investors seem to be chasing Eurozone yield in the form of Italian bond (BTP) risk.
The chart below is the weekly chart of the 10-yr. BTP yield. The pressure is on lower yields at the moment, with the chart focus on the purple line near 3.58% (December 2022 low) and then the December 2023 yield low near 3.46% below this. If investors chase yields below these levels then yield drops towards 3% and even 2.3% could be in play on a long-term view. The latter would be the simple double top extension measure for chart pattern fans! Keep in mind that the BTP was flirting with breaking above 5% last October, boy how market sentiment can swing eh? We are taking the view that some of the improvement in Italian bonds is that investors were pricing in the risk of a lot of negative news, and this risk has reduced, as far as investor sentiment is concerned.
Eurozone sovereign debt trades with an eye on yield spreads over core bonds, in this case the German 10-yr. bund yield (weekly chart below). The spread has been consolidating in a 160 bp to 125 bp sort of range over the last few months. The big move coming into the year was a narrowing spread, as this was near 250 bp in October 2022. If BTP yields fall further, then the spread may well narrow further towards 100 bp where it was in early 2021. The latter has been a difficult area to clear over the last 15 years, so odds are against a sustained narrowing move through here, for now anyway. It may be worth remembering that before the Eurozone debt crisis (and before the global financial crisis) the Italian 10-yr. BTP yield traded below 20 bp vs. the German bund yield, so it is not impossible to see the spread get crushed. But, odds are that Italy would need to convince investors not just that things are not as bad as they feared or likely to get worse, but that debt load worries have indeed turned a big corner.
As John Calverley, Tricio's Chief Economist notes, tempering optimism about BTPs and the spread over Bunds is concern about Italy's ongoing fiscal deficit (7.4% of GDP in 2023) and high government debt (expected to reach 140% of GDP this year). With financing costs higher than in the 2010's, a fast ageing population and weak productivity growth, Italy needs to urgently bring down government deficits. The government is moving on this, albeit slowly, and the EU has included Italy in its 'excessive deficit procedures' process, so there are hopes for improvement. But progress will be watched closely.
Gerry Celaya, Chief Strategist
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