23 April - update from one of our investment partners

  • 23rd April 2020

Italian sovereign bond yields have been rising over the last couple of weeks despite equities becoming more buoyant.

What has happened

It’s not often that a geopolitical tension can lead to a market rally but the comment by Donald Trump that he had authorised US navy vessels to fire at Iranian gunboats if they approached, led to a surge in oil that the equity market appreciated. One could perhaps comment that in the absence of a demand increase or a supply cut this tweet may have been partially designed to support the market but there is no time for cynicism with the many facets of the EU Council meeting to discuss.

The EU Council prepare their stimulus

There are stories of a €2trn fiscal support package which would be partially financed from the EU’s medium-term budget but also via a temporary financing mechanism. This financing mechanism is effectively joint debt and something that the EU has previously shied away from. Fiscal spending from the EU budget is less politically complex and therefore something that is more likely from today’s communique. Arguably it was more likely that the monetary union of the Eurozone was to adopt joint burden sharing than the full EU, so we have taken this leak with a pinch of salt. Regardless the key for sentiment will be progress and specifically progress towards something that coronavirus-impacted Southern countries are willing to sign up to.

What does Brooks Macdonald think

Italian sovereign bond yields have been rising over the last couple of weeks despite equities becoming more buoyant. This is because there are many knock-on impacts of the EU and Eurozone response on the political backdrop in Italy. Domestic tensions are already high given the perception that the Northern bloc are focused on their own economies but not the wider European communities. If support is dragged out further this is likely to make Italian citizens question the value of the Euro in particular. Whilst it has provided Italy with some stability the lack of a free-floating currency has meant the nation has lacked a release valve for economic pressures putting more pain on the domestic economy. If you take the perspective of the UK, the huge devaluation in sterling we saw post the EU referendum provided support to the UK economy, if the UK was part of a currency bloc more pain would need to be borne domestically. The other crunch point for the country will be the S&P rating announcement on Friday where it is possible that Italy moves into High Yield. The ECB seem to be preparing for this possibility with a change to the rules to allow some HY bonds as collateral. If we do see a downgrade, expect market attention to focus on Italy and further weakness in Italian bond yields.

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