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The Vittorio Emanuele II, also known as the Altare della Patria, top left, stands beyond rooftops in Rome, Italy. Photographer: Giulio Napolitano/Bloomberg

(bloomberg)

(Bloomberg) -- A rally in Italian bonds shows anxiety among the country’s investors might be turning a corner.

The yield on two-year securities fell to the lowest level in almost six weeks on Monday after Finance Minister Giovanni Tria added to reassuring signals that the country’s budget talks will adhere to European Union rules. His remarks led Morgan Stanley and NatWest Markets to expect further bond gains as the worst of Italy’s fiscal risk might be over in the short term.

Morgan Stanley sees Italy’s budget shortfall at around 2.2 percent of gross domestic product -- well within the 3 percent limit set by the EU -- and says investors should buy Italian 10-year bonds, selling similar-maturity Spanish securities. NatWest Markets thinks it’s time to consider “aggressively long” positions in the nation’s five-year bonds as market sentiment improves.

“There’s a lot of risk still priced into BTPs, so given the more constructive tone on fiscal policy coming from the Italian government there should be scope for further spread tightening over the short term,” said Michael Ingram, chief market strategist at W H Ireland Ltd.

The yield on benchmark 10-year securities fell 13 basis points to 2.90 percent, following a 20-basis-point drop last week. The spread over similar-maturity German bunds narrowed 14 basis points to 2.50 percent, the lowest in a month.

Stocks Advance

Italy’s FTSE MIB Index outperformed regional equities on the back of the bond moves to gain 2.3 percent, led by banks. The policies discussed by the new populist government have weighed down Italian stocks, taking the FTSE MIB from being the best-performing index in Europe to the second worst as their spending plans raised investor concerns.

The government in Rome is expected to set new public-finance and economic-growth targets by Sept. 27 and present them to parliament. This will be followed by the draft budgetary plan, which must be submitted to the European Commission by Oct. 15. The budget law has to be sent to parliament by Oct. 20, with final approval expected by year-end.

“As long as the Italian economy remains on a low growth trajectory, the tension between debt reduction aspirations and fiscal pump-priming can only increase,” Ingram said, adding this could lead to renewed volatility in the debt in the longer term.

--With assistance from Sam Unsted.

To contact the reporters on this story: James Hirai in London at jhirai3@bloomberg.net;Carolynn Look in London at clook4@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Neil Chatterjee

©2018 Bloomberg L.P.

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