When analysing the existing level of economic and geopolitical uncertainty in the EU, it’s easy to cite Brexit as the primary cause. While the UK’s departure from the European Union may be compounding economic issues in the single bloc, it’s fair to say that many of these existed prior to the referendum vote of 2016.
In the case of Italy, for example, this country has subsisted with high levels of government debt and political uncertainty for a period of years. These problems are now being compounded by rising levels of scepticism towards the European Union, and more specifically the way in which Italy is being forced to structure its debt.
So, despite the election of a new coalition government in Italy, confidence in the nation’s political system remains at rock bottom. This is impacting on the performance of Italy’s sovereign debt, and could even be the trigger for another election in the months ahead.
How have Private Bonds Continued to Outperform Sovereign Debt?
In simple terms, the bonds sold by Italy’s private firms have continued to outperform the nation’s sovereign debt in recent times, underlining the significant level of uncertainty that has gripped its political system.
The Markit iBoxx Total Return index of Italian corporate debt has declined by 2 per cent so far in 2018, while the equivalent benchmark for sovereign bonds has fallen by 3.3 per cent. So, while both asset classes have experienced declining yields in 2018, the value of privately sold bonds is falling at a far slower rate.
At the heart of this is the performance of Italy’s energy and consumer goods groups, which have continued to benefit from international income streams that have offset a weak domestic performance. Conversely, Italy’s banks are faring poorly, with the returns on their bonds taking a significant hit alongside their share prices.
While this is an unusual situation, the clear takeaway here is that investors continue to showcase greater confidence in its corporations than the presiding government. Most pointedly, there’s a concern that fresh elections may be called for if this uncertainty continues, and this is something that neither Italy or the Eurozone as a whole should be comfortable with.
What About the UK and the Pound? How have they Reacted to the News?
These recent developments have already impacted on the forex market, with GKFX reporting that the pound (GBP) managed to creep higher against the Euro (EUR) despite enduring a slow start to the week.
The Bank of England’s (BoE’s) decision to increase the base interest rate to 0.75% per cent played a role in this, of course, but the continued volatility in Italy remains one of the key triggers in this unexpected shift.
But will the UK be affected by the developments in Italy?
Well, given that most Italian corporations are governed by English rather than Italian law, it’s fair to surmise that UK investors will be well placed to leverage the improved performance of private bonds.
Perhaps a more pertinent question is whether a similar state of affairs could arise in the UK? After all, confidence has been low in the Conservative government given their largely inefficient handling of Brexit, while the most recent interest rate hike was confirmed after the BoE reported increased economic growth of 0.4 per cent during the second quarter.
This could create a scenario where investors develop greater confidence in private and corporate bonds, at the expense of the government and the nation’s sovereign debt.