Hostage-Taking Bond Markets

Is the bond market holding Italy hostage?

“Hostages” by Laurens. Public Domain. Source: Wikimedia

Over the past few days the Italian bond market has sold off. Market participants have been spooked by the prospect of a political alliance between the two major populist parties there – the Northern League and the Five Star Movement. The leaders of the parties have been in talks for months, ever since Italy’s elections in early March were inconclusive. The country has been operating without a government since then, and markets haven’t seemed to care very much.

But over the past week the League and Five Star leaders appear to have come to terms. Together, the two populist parties control over half the seats in Parliament. They’ve proposed a 15% flat tax, a universal basic income for all citizens, and a lower retirement age. This would bust their budget, so the coalition has also proposed abandoning the budget limitations Italy agreed upon when they signed the Maastricht Treaty and joined the Euro. The bond market, quite naturally, was spooked. If this program is enacted, where will Italy get the money they need to pay their bills?

Ten-year Italian Government bonds sold off hard, with prices falling and yields rising by 40 basis points in the last two weeks. We haven’t seen drama like this in the bond market since the Euro Crisis.

Source: Bloomberg

Coalition leaders are incensed. The market’s panic could erode popular support for their plans. Matteo Salvini, leader of the Northern League, posted on Facebook: “They are trying to stop us with the usual blackmail of rising spreads, falling stock markets, and European threats. This time change is coming.”

But markets don’t hold grudges, engage in vendettas, or have political agendas. They just care about money. In the case of the bond market, they want to know that the government can pay its bills. An aggressive fiscal program would generate huge deficits and require more borrowing. By a country with total debt that’s already over 130% of its economy.

A couple of decades ago US politicians were frustrated that our “bond vigilantes” could hold their fiscal plans hostage. But bond investors don’t take hostages. They just want their money back.

Douglas R. Tengdin, CFA

Charter Trust Company

“The Best Trust Company in New England”

By |2018-05-18T06:39:35+00:00May 18th, 2018|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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