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Italy's government bonds are euro area's 'high-yielding play' of the summer

Brussels

INVESTORS are snapping up Italy's government debt with as much appetite as during previous European summers, when the high yields proved the perfect place to pick up a steady return while volatility is low.

And the global pandemic, predicted to slash 11 per cent off the nation's economy this year - the worst in the euro area - isn't putting them off.

Italy offers the biggest yields in the region, with its 10-year bonds at around 1.2 per cent, higher even than Greek notes, which have long been the pariah in the region. For that, investors still get an investment-grade asset, as well as the safety of a liquid market.

"It is the high-yielding play in the region for sure," said Mark Dowding, chief investment officer at BlueBay Asset Management, who is positioned for longer-dated securities to climb. "We see spreads continuing to rally as political risks subside against the backdrop of increased eurozone solidarity in the face of the Covid crisis."

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Italian bonds rallied last month, the fifth straight year they have done so in June, despite frequent periods of intense volatility in between. In July, four out of the last five years have also seen the bonds prosper.

Part of the allure is the high carry, or the coupon payments collected for simply holding the bond, rather than betting on an appreciation. Then there's the roll, the profit received as a security moves closer toward its expiry.

Two-year bonds offer such a pickup of around 10 basis points. When calculating how much carry and roll an investor might be able to get, volatility is a key part of the equation, because it can jeopardise what is normally a steady return. That's why the summer - when there's a trading lull - is an attractive period to lock in such bonds. Volatility in the broader European rates market is hovering near a six-month low.

It's a far cry from March, when Italy became the first country in Europe to initiate a lockdown, bringing with it the realisation of just how hard the continent would be hit by the virus. Bond yields spiralled after investors perceived that European Central Bank (ECB) president Christine Lagarde might be reluctant to lend support, spurring fears of a fresh euro-area debt crisis.

That fear has now eased, with the ECB pumping trillions of euros into the region's economy through its pandemic asset-purchase programme. The buying has helped rein in the premium investors demand to hold Italy over haven German debt.

Italy "is one of the few developed market sovereigns with yields still positive and close or above inflation", said Alberto Gallo, a money manager at Algebris Investments, adding investors are not necessarily betting on a quiet summer. "They are still having a sigh of relief after the sell-off, but have not deployed much of their capital."

The bets on Italy could be scuppered if European Union leaders fail to reach an agreement at a summit in the coming days on proposals for a regional recovery fund.

If recent bond sales are anything to go by, appetite for Italian debt is booming. Last month, the nation was inundated with over 100 billion euros (S$157 billion) of offers from investors for a sale of 10-year bonds.

Italian bonds have returned investors around 2 per cent so far this year, comparable to that on German debt and more than the 1.5 per cent for Spain, according to Bloomberg Barclays Indices.

Charles Diebel, a money manager at Italian fund Mediolanum SpA, is among those invested. He's betting on a recovery deal between EU member states, albeit one that's perhaps less ambitious than currently outlined. Success means that the chances of the euro area breaking up would be eliminated.

"If you buy into the recovery plan then the euro exit tail risk is gone, so it's an appealing case," he said. "Some deal will be reached." BLOOMBERG

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