Italy’s funding strategy, primary market outlook for 2019 and the structure of Italian debt
Italy has recently published the yearly document in which the Treasury outlines its funding strategy for the upcoming 12 months (“Linee guida della gestione del debito pubblico - Anno 2019” MEF)
The guidelines outlined by the Italian Treasury on its funding strategy for 2019 show several detailed goals, but in a nutshell they point to transparency, managing primary market activity in a regular and forecastable way, and concentrating issuance where potential demand looks more robust and market depth greater. The diversification of the investor base is another goal for 2019, which could be targeted by possibly issuing in foreign currency.
The Italian Treasury also aims to optimize the mix between the average funding maturity and average funding cost over the year, which certainly looks more challenging than in previous years.
A challenging year in terms of issuance volumes
Among the curve segments, in relation to 2018, supply is expected to be lower at the belly of the curve (5 and 7-yr) and higher at the short end (2 and 3-yr) and long end (10-yr and 15-30 yr)
The expected distribution of the issuance mix among different curve segments seems to point to the goal of consolidating the structure achieved in recent years, in particular with a higher average maturity, while containing funding costs in light of the strong steepening in the yield curve in the latest quarters. Since early May 2018, in fact, 3-yr and 5-yr maturities have recorded quite a steepening vs the corresponding 2-yr, while the opposite took place in the 7-yr to 10-yr and extra-long segments. Moving onto a more detailed analysis by curve buckets we summarize the main points below:
What about trends in the cost of funding and the average maturity of Italian debt?
The year started with successful new issuance activity by the Italian Treasury
The Italian Treasury was quite active in the primary market at the start of the year. After just three weeks, in fact, new issuance of M/L term debt issuance already totaled more than EUR 25bn.
The Italian macro picture looks weaker
Thanks to the final agreement reached by the Italian government and the European Commission on the 2019 budget, pressure on the BTP has somewhat eased, a relief mostly due to the Italian Government’s implicit commitment to work within the EU framework of laws and institutions.
Yet we must acknowledge the increased risks of a technical recession in Italy, where the Q3 18 GDP reading was negative and Q4 also looks likely to be very weak. This in turn could put at risk the achievement of the deficit target for the year (2.04%) and the decline in the Debt/GDP ratio as well, because realized growth may be much lower than the assumption used to set the targets. The inflation path also looks likely to remain subdued.
While we expect the Italian economy will grow in the 0.5% range (actual forecast 0.4% YoY average for 2019), slightly below the baseline projections of the Ministry of Economy and Finance and the Bank of Italy (0.6% YoY in 2019), we also think that risks to the downside are high. Significant risks come from the external side: deceleration in global trade and slower growth in key euro area trade partners could weigh on the export-led part of the economy. On the domestic side, the decline in business confidence coupled with a slowdown in capex and private investments may be a drag on internal demand. Consumers still remain overall optimistic even though there has been a slight deceleration in real disposable income, and they have marginally increased their propensity to save, while the labour market keeps slowly declining. On the other hand, lower oil prices could represent an upside risk.
January saw the first wave of Italian BTPs being well received in the primary market, despite the lack of redemptions. In this respect, there will be redemptions again in the next two months, as EUR 23.1bn in BTPs will mature at the beginning of February and a similar amount will mature in March, therefore offering some support to the secondary market, and indirectly to upcoming auctions. Short-term technicals supported a partial return of foreign demand, as according to available data, “non-residents” had strongly reduced their holdings in the last three quarters of 2018. This would tend to explain the relatively high participation of foreign investors in Italian and other peripheral countries’ primary market and the distribution by investor type at a time when ECB rates are no longer expected to move up this year. Italy has already covered a significant portion of yearly net supply by issuing long bonds: its funding strategy aims to optimize the mix of average maturity and average funding costs, keeping the first stable while calibrating issuance across the steeper curve to address the second objective. Despite the slight rise in funding costs, the average cost of overall debt remains low vs previous years and should not be strongly impacted in the next one to two years. However, the year has just started and it remains quite challenging in terms of overall funding needs and supply, as we outlined in the numbers shown in the first section. Furthermore, the main medium- to long-term challenges still relate to the weaker macro trends we analysed in the last section and persisting political uncertainties in the Eurozone (Brexit and European elections, first) and outside the Eurozone.