Robeco: Peripheral Europe Update - Italian banking sector under stress

We maintain our cautious stance towards euro periphery debt, despite the ECB’s QE program.

11.07.2016 | 11:23 Uhr

  • Italian banking sector under stress 
  • EC advices to sanction Portugal and Spain 

Main market events

Peripheral government bond spreads widened somewhat this week. Spreads widened on the back of stress in the Italian banking sector, with Italian banking stocks declining significantly. Italian bonds have returned 3.59% this year, Portuguese bonds -1.36%, Spanish bonds 5.21% and Irish bonds 4.66%.

Italy

The main theme for this week was the stress in the Italian banking sector. The Italian government suggested that exceptional circumstances apply for the Italian banking sector, and the European bail-in law should therefore not apply. The bail-in law requires that in case of public capital support losses should be shared with bond and equity holders. According to Fitch it will be very difficult to provide public support without triggering the bail-in law. A bail-in would be painful for the political support of Renzi, since a significant amount of bank bonds is in the hands of Italian retail investors.

Portugal

The European Commission concluded that Portugal and Spain have failed to take effective actions to bring down their budget deficit. The fiscal measures taken by Portugal in the last two year adds up to 1.1% of GDP where 2.5% was recommended. For Spain is was even worse according to the EC, since implemented only a quarter of what was recommended. The EU ministers of Finance need to determine if a financial sanction should be applied. PM Costa of Portugal already mentioned that he opposes any sanctions, and ruled out any austerity measures. 

Robeco Euro Government Bonds

The lack of further reforms and the failure to improve public finances sufficiently in the current benign environment makes the periphery vulnerable. The Brexit will have ramifications for the peripheral countries, since it will result in further uncertainty and lower economic growth. Consensus positioning is overweight in the periphery and valuation is not really compelling. Changes in the ECB’s buying program could change our stance.

We don’t hold any short dated bonds of Italy and Spain due to unattractive valuations. The holdings of peripheral bonds in the fund have been increased from 20 to 24%, versus 39% in the benchmark. Year-to-date the fund’s absolute return is 6.23%*.

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