No longer the big outlier, Italy sees bond renaissance: Mike Dolan

Zawya

a day ago

(The opinions expressed here are those of the author, a columnist for Reuters.)
LONDON - As investors wring their hands about mounting public debt loads across the G7, Italy - a country traditionally seen as a poster child for profligacy and unsustainable debts - is enjoying a relative bond market rejuvenation.
Italy's borrowing premium over Germany, which typically reflects relative credit risk, bond supply and political risks, has halved in just two years to less than 100 basis points.
More remarkably, this spread - seen by many as the pivotal intra euro zone debt metric - is within a few basis points of post-pandemic lows reached in early 2021 and it's fast homing in on the smallest premium since before the euro debt crisis exploded in 2010.
While some investors may wonder if there's any more juice left in this trade, Italy traded with a premium of just 20bps over Germany before the global banking crash of 2008.
And yet after a decade and half of existential euro debt crises, domestic political upheaval, European Central Bank intervention, a pandemic and the invasion of Ukraine - the nearing milestones are remarkable.
Helped by recent European Central Bank easing, nominal 10-year Italian government borrowing rates of 3.5% are back at the average of the entire 26-year euro zone period.
IT'S ALL RELATIVE
G7 debt markets are often a relative game.
Italy's debt-to-GDP ratio - long in excess of 100% - is no longer such an extreme outlier. Even though its current 137% tally remains historically high, the figures for other advanced economies are fast catching up. Italy's debt burden is also one of the few in the G7 that's not projected to keep rising over the rest of the decade.
Japan comfortably retains that mantle as the most indebted G7 nation relative to its economic size. But U.S. sovereign debt has zoomed through 100% of GDP, and U.S. President Donald Trump's 'Big Beautiful Bill' making its way through Congress is expected to make that worse.
More obviously within Europe, once frugal Germany has also lifted its self-imposed 'debt brake' and committed to fiscal stimulus that will arguably buoy euro zone growth at large even as some see its debt-to-GDP ratio hitting at least 100% within 10 years.
And what is just as notable for European investors is that France's deficit and debt struggles mean Italy's risk premia have all but converged with those in Paris. At just 20bps on 10-year debt, it's the lowest since 2008.
And Unicredit strategists point out that the 3-year Italy-France spread briefly turned negative earlier this year for the first time in more than 20 years.
Once Europe's largest debt pile, Italy's gross government debt outstanding was overtaken by France four years ago. At 3.3 trillion euros last year, according to Eurostat, France's debt pile was last year some 300 billion euros bigger than Italy's.
Aided by a relatively stable government by Italy's fractious post-war standards, Prime Minister Giorgia Meloni's administration has been in power since 2022 and Italy's credit ratings are starting to turn up.
In April, rating agency S&P Global raised its rating on Italy to "BBB+" from "BBB" in a surprise move and last month Moody's upgraded the outlook on its 'Baa3' rating to "positive".
Moody's cited a "better-than-expected" fiscal performance last year and a "stable" political environment, providing a boost for Meloni's plan to keep a lid on annual budget deficits - projected at 3.3% of GDP this year and 2.8% in 2026.
"The positive outlook is also supported by a robust labor market, sound household and corporate balance sheets and a healthy banking sector," Moody's said in its report.
Goldman Sachs economists this month raised questions about whether the increasingly benign Italian government bond pricing had gone too far given still much-needed structural changes in the economy and a rising European defense spending.
But it said there were three 'ameliorating factors' - ongoing fiscal space provided by European Union recovery funds through next year, higher 'real' rates due to disinflation, and continued stable government.
What's more, they said higher defense spending may lift Italy's deficit and debt metrics along with other euro countries but joint EU bond sales to fund that meant Italian bond issuance would not increase and the average maturity of its debt could extend further.
On top of that, Goldman pointed out, the Italian fiscal balance is improving at the fastest pace among the biggest four euro zone governments - bringing the gap with the euro zone average to its lowest in almost 10 years.
Once again, it's all relative.
Italy still has a debt problem - but increasingly so too do all its peers. Rome is getting rewarded for keeping it in check at least.
The opinions expressed here are those of the author, a columnist for Reuters.
(by Mike Dolan; editing by Deepa Babington)