Calling A Bottom In 10-Year Government Yields
We believe that Italian 10-year government yields have reached an inflection point after falling to all-time lows in mid-April, and are initiating a bearish asset class strategy view at an entry level of 3.16%. This is not based on expectations of deteriorating credit risk, and as such we do not expect a spike in borrowing costs similar to those witnessed in 2011 and 2012. Instead, we see yields gradually rising as a result of an improving growth outlook and a bottoming out of disinflation in the eurozone. The technical picture also suggests that the momentum underpinning the sustained rally in Italian fixed income is waning.
Disinflation, in conjunction with improving perceptions of credit risk on the back of the European Central Bank's Outright Monetary Transactions (OMT) programme, have supported fixed income demand and driven a strong positive correlation with equity performance. As we remain bullish on Italy's FTSE MIB equity index in our asset class strategy, we expect this correlation to abate.
It is our view that the OMT's effect on narrowing credit risk in the eurozone periphery has largely run its course, with the spread of Italian over German credit default swaps at pre-eurozone crisis levels. More recently, eurozone disinflation has caused markets to price in a relatively high probability of the ECB enacting some of sort quantitative easing (QE) programme, strengthening the risk-free perception of periphery government debt.
|Italy - 10 Year Government Bond Yield, weekly, % And Relative Strength Index (bottom)|