Spain has been without a government since national elections in December 2015. No party has managed to secure a majority in those elections, leading to the most fragmented parliament since 1977. A second set of elections (held in late June 2016) was meant to resolve the political deadlock, but again no party won enough seats to gain an outright majority. The incumbent party (People’s Party) formed an alliance with a smaller party (Ciudadanos) but remained about 11 seats short of an overall majority. Since then, protracted negotiations have continued to try to find a solution, which would most likely be a minority Peoples Party/Ciudadanos government. However, Spain’s second largest party, the socialist Partido Socialista Obrero Español (PSOE), have steadfastly refused to support such a solution. Last week, however, cracks began to appear in the PSOE party. Seventeen members of the 38-strong PSOE executive committee stepped aside in a protest aimed at the party’s leader Pedro Sanchez. These executive members are unhappy at Mr Sanchez’s on-going attempts to form a government relying on the support of the left-wing Podemos party and other nationalist parties. The 17 PSOE members appear to support the formation of a PP-led minority government, which must happen before the end of October to avoid triggering a third set of national elections in December 2016. Mr Sanchez resigned over the weekend, potentially increasing the chances of the Socialists supporting Mr Rajoy in a minority government. And it’s not as if the bond markets are punishing Spain for not having a government – Spanish bonds have been one of the best performers in the last 6 months. Spanish 10-year bonds now yield 31bps lower than Italian government bonds. In the past Italian bonds used to yield less than Spanish bonds. With political risk on the rise in Italy (see below), Spanish government bonds look set to continue to outperform Italian government bonds.
2. The Italian Job – Referendum Date Set :
Last week it was announced that the much-anticipated Italian referendum on political reform will take place on December 4th. On this date, Italian voters will be asked to give their approval to a set of reforms that would significantly change the political framework. Essentially, the Senate (the upper Chamber) would become smaller and have most of its legislative power removed. A new electoral law (the “Italicum”) would lead to a more stable government. In theory, all positive things for Italy but there has been some criticism that these reforms will lead to a concentration of power. As of now, the outcome is too close to call, whilst the proportion of undecided voters is quite large.
Italian Prime Minister Matteo Renzi had initially suggested he would resign if the referendum was not passed, although Interior Minister Angelino Alfano made it clear over the weekend that the government would not resign in the event of a “No” vote. Whether Renzi could continue in power remains another question, with some commentators suggesting new elections could be called in Q1 2017, or that Mr. Renzi would lead a government with limited powers before going to the country in Q2 2017. That could mean that in the next 12 months there could be general elections in at least four of the five largest euro-area countries along with the Brexit negotiations. Our colleagues have written a more detailed piece on the Italian referendum (Read More Here), but the bottom line is that we should expect increased volatility in Italian assets in the run-up to the referendum, which could provide interesting opportunities.
We are currently recommending a neutral stance to Italian sovereign bonds, but would change to a more constructive stance in the event of a significant widening of spreads against German Bunds. This view is reinforced by the positive demand/supply dynamics for Italian sovereign bonds in Q4 2016, as outlined below.
3. Bond Supply for Q4 2016 – More Demand than Supply :
Debt management agencies usually follow a typical pattern when setting their issuance calendar for a year. The idea is to front-load issuance into the first 6 months of the year (when there is good demand for bonds), then reduce issuance over the summer period (when investors are on vacation) before resuming bond selling from September to November. Hopefully, if all goes to plan, a sovereign’s funding needs will have been completed by the end of November, avoiding the need to do large-scale issuance in December. Therefore, Q4 issuance patterns are generally lighter than in earlier quarters in the year. The advent of the European Central Bank’s (ECB) Quantitative Easing programme has brought another dimension to the demand/supply equation. Although the ECB tend to scale back their bond buying in August (to take account of the vacation period), the scale of purchases remains pretty constant throughout the rest of the year. In our opinion, the combined picture of reduced bond issuance with continual ECB buying could set the tone for a strong end to the year for European sovereign bonds. According to calculations by Deutsche Bank, gross issuance of Euro-area bonds in Q4 will amount to €149.3bn, which sounds like quite a lot. However, take into account that many sovereign bonds also mature in Q4, and the actual net issuance figure falls to a very low €7.4bn. Then factor in the ECB’s bond buying programme, which is set to buy €185.4bn in that period and you can see just how much demand exceeds supply for sovereign bonds in Q4 2016. What’s also interesting is that this excess demand picture occurs in every sovereign state in Europe, with some obvious bigger beneficiaries than others (See table below). All other things being equal, it’s hard to see bond yields rising much against this backdrop.
|Country||Gross Issuance (€bn)||Net Issuance (€bn)||ECB Buying (€bn)|
Source: Deutsche Bank, Pioneer Investments. 30 September 2016.