Caution advised for bond investors as Italy referendum looms

Added 23rd November 2016

Whereas equity markets have quickly shrugged off the result of the US presidential elections, peripheral bond spreads have widened since. Trump’s election seems to have reminded markets of the possible consequences of an Italian no-vote in next week’s referendum.

Caution advised for bond investors as Italy referendum looms

On 4 December, Italy will vote in a referendum on constitutional changes initiated by prime minister Matteo Renzi, who has tied his political future to the referendum outcome. With the no-vote in the lead according to the latest polls and populist politicians on the right and left eager to fill the vacuum left by Renzi, investors require a higher risk premium.

“And the political risk in Italy is driving yields in Spain [and Portugal] up too,” says David Zahn, head of European fixed income at Franklin Templeton Investments. Italian and Spanish 10-year bond yields are now at their highest levels since June 2015, having doubled since August. Portuguese 10-year yields even yield 3.7% now, more than at any point since March 2014. German bunds, meanwhile, have moved up only a little from record lows since the US elections, meaning spreads have been widening considerably. Are we on the way to a repeat of the euro crisis that spooked markets a few years ago, or is this the time to place a contrarian bet?

Risk off

Alessandro Viviani, a fund analyst at Old Mutual Wealth Italy, is taking no chances. “From mid-October, (as polls started suggesting the likelihood of a ‘no-vote’ was rising, we started gradually to reduce the duration of our Italian government bond exposure,” he says. Viviani and his colleagues had already reduced the duration of their government bond portfolios across the board over the summer. He is certainly not the only investor having made such a move: government bond yield curves have steepened significantly, with the 2-year Bund yield hitting a record low on Tuesday even though 10-year Bund yields have reached their highest level since January.

“We could see a return of the eurocrisis and a divergence between core and peripheral bond yields,” believes Viviani. “Today we are still invested in Italian government bonds, but we will closely monitor the result of the Italian referendum, the consequences on Renzi’s government and the market reaction.”

“We could see a return of the eurocrisis and a divergence between core and peripheral bond yields" - Alesssandro Viviani

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Tjibbe Hoekstra

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Tjibbe joined Expert Investor as a senior reporter in March 2014. Before moving to London he worked as a financial news reporter for various news outlets in Amsterdam, including Reuters and ANP, the main news agency in the Netherlands. He also worked for Fondsnieuws, a website and magazine for finance professionals in the Netherlands. Tjibbe holds a MSc in Public Administration and a post-graduate diploma in Journalism.

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