The four-month rally in Italian bonds risks stalling as former Prime Minister Silvio Berlusconi ponders a comeback that will further shake up the political landscape before next year’s election.
Berlusconi’s possible return, a month after he said he wouldn’t run, comes as the extra yield investors demand to hold Italian 30-year bonds instead of similar-maturity German bonds fell to the lowest since August 2011. The market signals investor confidence is returning after the European Central Bank offered a bond-buying backstop to defend the euro and Italian Prime Minister Mario Monti implemented an economic overhaul to contain the region’s second-biggest debt.
“Political risk may be priced in again in the new year,” said Ralf Ahrens, who helps manage about $19 billion as head of fixed income at Frankfurt-Trust and holds Italian bonds. “We are cautious because we see that the rally has lasted for several months.”
Italian securities due in at least 10 years have returned 7 percentage points more than the average for top-rated German, Finish and Dutch securities since ECB President Mario Draghi announced on Sept. 6 a plan to buy government bonds of nations that request aid. Draghi’s July pledge to do “whatever it takes” to defend the euro, along with the ECB backstop, eased the perceived risk of a euro breakup.
Thirty-year Italian bond yields fell 37 basis points, or 0.37 percentage point, in November. They dropped to as low as 4.40 percent today, the least since December 2010. The spread relative to similar-maturity benchmark German bunds narrowed to 283 basis points today from a euro-era record of 519 basis points in November 2011.
“The Italian rally has been very impressive,” said Mohit Kumar, head of European fixed-income strategy at Deutsche Bank AG in London. “The election is a risk that will be apparent in the first quarter of next year.”
Billionaire Berlusconi said on Nov. 24 he may break with the People of Liberty party, or PDL, that he founded to start a new movement and seek the premiership. The announcement upended PDL primaries scheduled for Dec. 16 that were set to anoint Secretary General Angelino Alfano, Berlusconi’s hand-picked successor, as the candidate.
Alfano met with Berlusconi for five hours on Dec. 1 and said afterward that the primaries would still take place and that it would be Berlusconi’s decision whether to run. Berlusconi, 76, may announce his new party as soon as this week, newspapers including the Berlusconi-family-owned Il Giornale have reported.
Monti’s austerity may be at risk with lawmakers such as Berlusconi, who supported his unelected government, appealing to voters weary of a recession in its second year. Joblessness climbed to a 13-year high of 11.1 percent in October.
A Berlusconi party would be backed by 9 percent of voters in elections due by May, giving him the third-biggest political force in the country, according to a poll released Nov. 30 by SWG. Berlusconi may also build a coalition with his old party, the PDL, and possibly resurrect his ties with the regional Northern League, a collation that would boost his clout.
“Italy isn’t a focus of the market, but there are elections coming up early next year, and this could be a risk factor to have a closer look at,” said Christian Reicherter, an analyst at DZ Bank AG in Frankfurt. “It’s possible the spread will widen when we come closer to that. It’s a risk factor and I’m not quite sure it’s priced into the spread.”
A Berlusconi return may backfire, further fracturing the parties on the center-right and aiding Democratic Party leader Pier Luigi Bersani in his bid to succeed Monti. The Democratic Party and its allies would probably win about 30 percent of the vote if elections were held today, according to the SWG poll.
Bersani also has backed the Monti government, though he’s said he would consider amending Monti’s labor market reform and pension overhaul.
When Monti was appointed after Berlusconi’s government unraveled 12 months ago, 10-year Italian bond yields exceeded 7 percent. Monti, 69, adopted additional austerity measures to contain the euro region’s second-biggest debt, overhauled the pension system and revamped labor laws. Since Monti was sworn in, Italian bonds of all maturities have delivered the highest returns of the euro-area nations that haven’t received outside assistance.
Italian bonds maturing in at least 10 years have made 9.6 percent since Sept. 6, according to indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies. That compares with gains of 1.9 percent for Germany, 2.8 percent for Finland and 3.1 percent for the Netherlands, which all have the top AAA grade from the three major ratings firms.
Moody’s Investors Service rates Italy’s debt Baa2, the second-lowest investment grade. Since the end of November 2011, Italian bonds of all maturities have made 26 percent, trailing only those of Portugal and Ireland in the region.
For now, the ECB backstop is overriding concern that reforms will be derailed by politics, according to Georg Grodzki, head of credit research at Legal & General Investment Management in London.
“The greed is at the moment overriding the fear,” Grodzki said. Legal & General has $290 billion of bond funds.
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