Italy's Bonds Poised for Gains as German and French Uncertainty Grows

While Italy's economic growth stalls and its debt burden continues to rise, investors are increasingly drawn to the country's government bonds, reports Reuters. This unexpected shift in sentiment stems from a growing perception that Rome's political landscape is far more stable than those in Germany and France, leading to a surge in interest in Italy's high-yielding BTPs.

"Italy is no longer considered the sick man of Europe," said Christopher Dembik of Pictet AM to Reuters, highlighting a change in investor perception. This newfound confidence in Italy's political stability is driving down borrowing costs, just as Rome prepares to issue between €300 billion and €310 billion in medium- and long-term bonds next year.

The yield gap between Italian BTPs and German Bunds has already narrowed to a three-year low this month, and with Germany teetering on the brink of recession, analysts anticipate this trend to continue. Investors are also increasingly viewing Italian BTPs as a safe haven compared to French OATs, given the ongoing political and budgetary turmoil in Paris. Dembik noted that Japanese investors, in particular, are shifting funds from French to Italian debt.

"So far the French political and fiscal crisis has had no impact on broader European spreads, but if it accelerates and turns into a financial crisis then BTPs will not be immune," said Aymeric Guedy of Carmignac to Reuters.

Despite this optimistic outlook, several factors could derail this BTP bull market. Italy's weakening economy could jeopardize promised fiscal consolidation, diminishing returns on BTPs, while a return of global risk aversion could also hurt demand. Additionally, the potential for a French financial crisis, though currently viewed as low risk by analysts, could spill over and negatively impact BTPs.

Analysts are also closely watching credit ratings agencies, which could play a significant role in 2025. Improved investor sentiment towards Italy and other peripheral countries could lead to rating upgrades. "The agencies may find it easier to reward than to punish," said BBVA fixed income strategist Filippo Mormando.

However, not all analysts are convinced that the BTP-Bund spread will fall below 100 basis points. The effectiveness of Italy's ability to utilize funds from the European Union's post-COVID-19 Recovery Fund will also play a crucial role in determining BTP performance in 2025. "Growth in 2025 will depend crucially on how well the Recovery Fund money is spent," said ING senior economist Paolo Pizzoli.