Looking beyond Italian Regional Elections: what will happen to BTP's Yield Curve?

The political situation in Italy could become more tense in the coming months, especially if the governing parties ( Democratic Party an Five Star Movement ) will suffer significant defeats in these regional tests. The evolution of the COVID-19 crisis adds a further level of uncertainty. However, my perception is that in the imminent use of the EU funds coming for the Recovery Fund Act (209 billion euro of which 82 billion euro non-refundable) there is sufficient political will among the governing parties to avoid the dissolution of the current parliament.

The formidable opportunity for the governing parties is precisely to manage a highly expansive public spending for domestic demand in the next 2 years, as well as a reduction in the tax burden for families and businesses. The management of the "Recovery Plan" is a management that will pay a lot in terms of “electoral consensus” and the fruits will be reaped in 2023 , when there will be the "natural" political elections.

In my opinion the most likely scenario remains that Italy will avoid a dissolution of the 2 Houses and early elections in the next 18 months. There are 2 other strong incentives to continue the current legislature and avoid the use of the ballot box: 1) the opportunity to appoint a new President of the Republic and 2) to avoid the rise of the Right Parties ( Northern League and Brothers of Italy ) in getting the power for the next 5 years. These parties , notoriously, have always had an anti-euro and anti-European attitude. These last two factors represent a strong link for the parties of the current coalition in power and make them eager to avoid the dissolution of the Parliament in the short term. However, I recognize that, due to the growing political uncertainty that awaits us, we cannot exclude a new post-refendum cabinet or even the formation of a new government, with a new Prime Minister ( but always supported by Democratic Party and 5 Star Mov. ) . This event certainly represents a possibility - albeit remote - . What are the implications on the BTP ‘s yield curve ? 

BTP 10y  have shown - since the day of the announcement of the Recovery Fund made by Merkel and Macron in mid-May - an exceptional rally. The spread between BTP 10y and Bund 10Y came from about 260 bps on 20th of April to the lows of 138 bp in mid-August and then - moderately corrected - reaches its current 145 bp. At the current levels, the spread of the BTP-Bund 10Y is at its narrowest point since 24th of February and just 15 bp above its pre-COVID-19 lows. This is clearly positive for those who already have BTPs in their portfolio and want to take profit now . Instead , I would be against the idea of buying now . Going “long” on BTP is now less favorable than a few months ago, and the price levels seem a little bit stressed. For those who want to buy now, it is better to wait . A temporary widening of the spread is possible if we’ll see the advance of the center-right coalition consensus . But since the most likely scenario is that Italy will avoid the early elections in the next 18 months, I do not expect that the political "noise" of a possible defeat of Democratic Party in Tuscany could lead to an exceptional and lasting increase in the 10-year yield spread of the BTP over BUND (over 160bps I mean ). Therefore we have to monitor the 160bps area . If we had to return to a spread of 160bps in the days immediately following the regional election results, then this would be an excellent opportunity to buy the BTP10y , an opportunity that will persist for the near future. The permanence of Italy in the euro area , strengthened by the indissoluble link with the other European countries after the agreement on Recovery Fund, ensures the constant monitoring by the ECB of the yield curves of the "weak" countries (Portugal, Italy and Spain) and therefore the "protection" of the BTP yield curve by the Central Bank through the Quantitative Easing.