# Analysis: The quiet revolution in Italian bond markets Author: Pal Sinha, Barnali Author URL: https://financedigest.com/author/pal-sinha-barnali Published: 2021-07-13 Category: INVESTING Category URL: https://financedigest.com/category/investing Meta Title: Italian Bond Market Volatility Decline Meta Description: Discover the sea change in perception towards Italian government bonds, with volatility at its lowest in over three years. URL: https://financedigest.com/analysis-the-quiet-revolution-in-italian-bond-marketshtml ![undefined](https://prod.superblogcdn.com/site_cuid_cm5qst7v3003gwirgwqtxn8i8/images/2021-07-13t114108z1lynxmpeh6c0mmrtroptp4eurozone-bonds-1736838185150-compressed.jpg) By Dhara Ranasinghe and Stefano Rebaudo LONDON (Reuters) – A calming down of Italian government bonds, typically among the most volatile in the euro zone, suggests a sea change in the way foreign investors perceive the 2.3-trillion-euro ($2.7 trillion)market — the bloc’s biggest. Volatility, the propensity of an asset to display wild and unpredictable price swings, is generally a negative for bond returns over time. So the message from one volatility indicator on BTPs, as Italian government bonds are known, will be [welcomed by investors](https://www.financedigest.com/bayer-hits-8-month-high-as-investors-welcome-ceo-change.html "Bayer hits 8-month high as investors welcome CEO change"). That indicator is an index of 30-day option-implied volatility on BTPs, which has fallen to around 50 basis points, around half its level a [year ago and approaching levels seen for higher-rated French and German government](https://www.financedigest.com/2016-must-be-the-year-of-board-level-transparency-and-good-governance.html "2016 must be the year of board level transparency and good governance") bonds. The BTP volatility index, based on a working paper from the European Stability Mechanism, is also the [lowest since more than three years](https://www.financedigest.com/u-s-weekly-jobless-claims-fall-layoffs-lowest-in-more-than-21-years.html "U.S. weekly jobless claims fall; layoffs lowest in more than 21 years") ago, when options on BTP futures first started trading. Italian [bond market](https://www.financedigest.com/stocks-up-bond-yields-fall-as-markets-mull-a-fed-policy-pause.html "Stocks up, bond yields fall as markets mull a Fed policy pause") volatility slides https://graphics.reuters.com/EUROZONE-BONDS/xlbpgqwbypq/chart.png What we’re seeing in Italian bonds is a little bit of a replay of the convergence trade that we’ve seen in the past, when euro zone [bond markets](https://www.financedigest.com/global-bank-bonds-claw-back-losses-as-markets-rout-eases.html "Global bank bonds claw back losses as markets rout eases") started to trade on this idea that over time every member state could issue (debt) at the same level,” said David Arnaud, a senior fund manager at Canada Life Asset Management. He was referring to the period before the 2011-2012 crisis when weaker states such as Italy and Greece enjoyed borrowing [costs only marginally above those of financially](https://www.financedigest.com/how-much-does-cloud-based-financial-software-cost.html "How Much Does Cloud-based Financial Software Cost?") robust Germany or the Netherlands. The yield gap ballooned during the crisis and then during [periodic market](https://www.financedigest.com/cosmetic-procedures-market-to-raise-at-a-cagr-of-7-5-over-the-forecast-period-2017-2025.html "Cosmetic Procedures Market To Raise At A CAGR Of 7.5% Over The Forecast Period 2017-2025") selloffs, including last year, but has since snapped in. The steep volatility decline has followed and this time some believe it may [last longer](https://www.financedigest.com/brand-loyal-brits-have-longer-relationships-with-their-car-than-their-last-lover.html "BRAND-LOYAL-BRITS HAVE LONGER RELATIONSHIPS WITH THEIR CAR THAN THEIR LAST LOVER") than before. ECB, EU, DRAGHI Several factors are driving the change in [investor perceptions towards Italy](https://www.financedigest.com/investor-appetite-for-italy-returns.html "Investor appetite for Italy returns"). First is the [European Central Bank’s bond-buying programme which has pinned down borrowing costs](https://www.financedigest.com/analysis-east-europeans-count-their-pennies-for-christmas-as-food-costs-soar.html "Analysis-East Europeans count their pennies for Christmas as food costs soar") across the euro area. Second is the European Union’s 800-billion-euro post-pandemic recovery fund, of which Italy is a major beneficiary, standing to [receive some 200 billion](https://www.financedigest.com/petrofac-hitachi-energy-receive-14-billion-agreement-from-tennet.html "Petrofac, Hitachi Energy receive billion agreement from TenneT") euros in grants and loans in the coming years. Since then, Italy’s anti-euro parties, including the far-right League, have become much less vocal in their opposition to the EU. Finally, the appointment in February of former ECB chief Mario Draghi as prime minister raised hopes that Italy could more [effectively use recovery fund monies to boost](https://www.financedigest.com/the-brexit-effect-hits-uk-salaries-but-possibly-boosts-tourism.html "The Brexit Effect Hits UK Salaries, but Possibly Boosts Tourism") economic growth. All this has squeezed Italian yields lower, even as the COVID-19 [crisis is projected to send Italy’s debt-to-GDP ratio — Europe’s](https://www.financedigest.com/europes-energy-crisis-and-the-nuclear-path-out.html "Europe’s energy crisis and the nuclear path out") second-highest — towards 180%. We think that the [market has underestimated the impact of the recovery plan](https://www.financedigest.com/how-businesses-can-effectively-pivot-marketing-game-plans-for-christmas-2020.html "How businesses can effectively pivot marketing game plans for Christmas 2020"), particularly in Italy, and Draghi has under-promised and will over-deliver,” said Jacob Nell, Morgan Stanley’s head of European economics. Last week the Italian government [agreed amendments to a law overhauling](https://www.financedigest.com/nissan-and-renault-agree-to-overhaul-alliance-this-time-as-equals.html "Nissan and Renault agree to overhaul alliance, this time as equals") the criminal justice system, a key reform plank included in the Recovery and Resilience Plan. LOCK-STEP It’s not just [volatility gauges showing Italian bonds](https://www.financedigest.com/fed-watch-prepare-for-more-bond-market-volatility.html "Fed watch: Prepare for more bond market volatility") converging with higher-rated peers. Italian and [German yields have moved in lock-step over recent](https://www.financedigest.com/german-yields-steady-spreads-tighten-after-recent-repricing.html "German yields steady, spreads tighten after recent repricing") months, suggesting investors view Italy as less risky than before, at least for now. That’s despite Italy’s Baa3 [credit rating from Moody’s and BBB- rating with Fitch — nine notches below Germany’s triple-A score](https://www.financedigest.com/1-in-5-uk-adults-have-no-idea-what-a-credit-score-is.html "1 in 5 UK adults have no idea what a credit score is"). Unicredit analysts estimate that 75-day correlations between Italian and [German bonds](https://www.financedigest.com/german-bond-yields-rise-after-schnabel-fuels-inflation-worries.html "German bond yields rise after Schnabel fuels inflation worries") have risen to 0.8 from around 0.4 just before Draghi’s appointment. Back in 2018, just after an [election in Italy that boosted anti-euro parties](https://www.financedigest.com/centre-right-gerb-party-leads-in-bulgaria-election-partial-results.html "Centre-right GERB party leads in Bulgaria election -partial results"), the correlation was -0.4, they said. Correlations between [Spanish and German debt are broadly steady this year](https://www.financedigest.com/10-year-david-goliath-crusade-finally-sees-justice-for-off-plan-spanish-property-buyers.html "10 year ‘David & Goliath’ crusade finally sees justice for off-plan Spanish property buyers"). The increase in the correlation between BTP and Bund yields indicates that the market is [dealing with Italian debt](https://www.financedigest.com/analysis-no-china-no-deal-bid-to-break-sovereign-debt-logjams-gets-weary-thumbs-up.html "Analysis-No China, no deal: Bid to break sovereign debt logjams gets weary thumbs up") as an asset driven more by the general macro fundamentals than by country-specific factors,” Luca Cazzulani, UniCredit’s co-head of strategy research, said. He [forecast the correlation at current high levels for a “prolonged period.”](https://www.financedigest.com/automotive-body-in-white-sales-at-3-4-cagr-over-the-forecast-period-from-2021-to-2031-reaching-us-59-7-billion-in-2021.html "Automotive Body in White sales at 3.4% CAGR over the forecast period from 2021 to 2031, reaching US$ 59.7 billion in 2021") Investors still demand a 100 basis-point premium over German [bonds to hold Italian 10-year debt](https://www.financedigest.com/green-bonds-are-set-to-drive-corporate-esg-debt-out-of-slump-in-2023-barclays.html "Green bonds are set to drive corporate ESG debt out of slump in 2023 -Barclays"), reflecting risks of premature ECB policy tightening or changes in the political scenario in Rome. “These two factors (a Draghi-led government and a dovish ECB stance) need to stay in play. If there was a hawkish [turn by the European Central Bank](https://www.financedigest.com/governments-and-central-banks-risk-inflation-bank-of-england-has-done-its-bit-now-the-politicians-turn.html "Governments and central banks risk inflation, Bank of England has done its bit, now the politicians’ turn"), it would be challenging for Italian debt,” Cazzulani added. French, Spanish and Italian bond correlation vs Germany https://fingfx.thomsonreuters.com/gfx/mkt/yxmvjzjrzvr/BTP0607.PNG ($1 = 0.8444 euros) (Reporting by Dhara Ranasinghe in [London and Stefano Rebaudo in Milan; Editing by Sujata Rao and Timothy Heritage)](https://www.financedigest.com/london-fears-losing-luxury-shoppers-to-paris-and-milan.html "London fears losing luxury shoppers to Paris and Milan") --- This blog is powered by Superblog. Visit https://superblog.ai to know more. ---