Stock Market News Today 2018/09/06
The region’s stock markets face multiple challenges, from the economic risks around Brexit to rising anti-EU sentiment to the winding down of the European Central Bank’s quantitative easing programme. But, for now, it is hard for investors to look beyond Italy. The anti-EU stance of the country’s coalition government, made up of the populist Five Star Movement and the League, has helped drive bond yields sharply higher and weighed on the country’s stock market since May.
In a sign of how sensitive investors are towards the eurozone’s third-largest economy, soothing words this week from deputy prime minister Matteo Salvini over the government’s budget plans have been enough to trigger a sharp rally in Italian bonds and send shares of the country’s banks higher over the past few days. Investors’ anxiety in recent weeks has been driven by the prospect that the coalition’s debut budget extends Italy’s fiscal deficit, setting up a clash with both Brussels and the country’s finance minister Giovanni Tria, who is widely seen as a moderating force within the government.
Camille De Courcel, an interest rate strategist at BNP Paribas, said Italy’s budget plan would leave its deficit closer to 2 per cent of gross domestic product than 3 per cent. The spread between Italian bond yields over German, the benchmark for the eurozone, remains near the highest level since 2014.
“If we do see that 2 per cent number, we would expect some compression in Italian spreads,” said Ms de Courcel.
Whether Rome can craft a budget that keeps spending under control matters to Italy’s banks, given their close links and exposure to Italian government debt. The fall in Italian bank shares since late April is closely connected to its stressed government debt, said Paola Toschi, global market strategist at JPMorgan, because about 18 per cent of the country’s sovereign bonds are held by its lenders.
“This creates a direct relationship between how the government bonds move and how the Italian banks perform in the equity markets,” said Ms Toschi.
Italian government bonds have suffered a sharp sell-off this year and last week the government paid the most in four years to raise debt in a €7.75bn bond sale. Salvatore Rossi, the Bank of Italy’s deputy governor, warned last week that the “vicious link” between sovereigns and banks had not been cut. At the same time, a lacklustre Italian economy lacking fiscal stimulus will do little to help Italy’s banks reduce their large burden of non-performing loans.
The fate of bank shares helps shape that of the wider Italian stock market as financials account for a fifth of the weighting of Milan’s FTSE MIB index, according to Bloomberg data. Of the FTSE MIB’s 10 worst-performing stocks since the start of May, five are banks. In turn, the MIB is 4.4 per cent lower over the same period.
“Italian banks look most vulnerable,” said Ms Vohora, “and by comparison with Brexit and UK domestic banks, they look to suffer a similar fate.”
The weakness in emerging markets is also a headwind for some lenders. Italy’s biggest bank, UniCredit, has been caught up in Ankara’s economic firestorm thanks to its 40.9 per cent ownership of Turkish bank Yapi Kredi. Shares in the Italian lender are down 26 per cent since the start of May.
Sovereign debt sell-off leaves lenders with paper losses that have hurt stock.
UniCredit held €54.5bn worth of Italian sovereign bonds at the end of last year.
The Italian banking system has been cleaning house for some time — lenders have consolidated, bad loans are being sold and bond markets are still providing fresh funding.
According to the Bank of Italy, Italian government bonds accounted for about a 10th of the assets at Italian banks at the end of 2017. Intesa Sanpaolo held €76bn worth of Italian sovereign bonds at the end of last year while UniCredit had €54.5bn. Shares in the former are down 21 per cent on the year; the latter are off 19 per cent.
Following this year’s sell-off of government paper, banks have been left with paper losses, denting investor confidence and hurting their stock value. The first major move in May was triggered by politics. The Eurosceptic leanings of a new coalition, comprising the League and Five Star Movement, unnerved investors.
However, some analysts think the doom and gloom is overdone. Collectively, the FTSE Italia All-Shares banks are trading on a price-to-book value of 0.65. In the US, the S&P 500 banks index trades at 1.34. Brave investors might see this as a buying opportunity for cheap Italian lenders. Italy’s story may not be la dolce vita but there are signs that could encourage banks. Its debt-to-GDP ratio had been trending downwards and fiscal expansion could help kick-start the economy.
But like many of the eurozone’s financiers, Italian banks are struggling to achieve top-line growth. With low negative central bank interest rates, any real rebound for banks is hard to see. Some things are cheap for a reason.
EU-wide deposit insurance is the best antidote to populism. Monetary hawks need to overcome their obsession with Italian ‘freeriding’.
Donald Trump’s feud with Turkish president Recep Tayyip Erdogan is making the case for EU monetary moderation and integration compelling.
The US president’s reckless threats to double the tariffs on steel from Turkey have sent the Turkish lira crashing on the foreign exchanges. They are also putting French, Spanish and Italian banks with substantial investments in Turkey in serious jeopardy.
Given the possibilities for contagion, another European banking crisis could be around the corner. But this is not all Mr Trump’s fault. If you live in an earthquake zone and do not take out earthquake insurance, that is your fault. There would be no cause for concern had the European authorities put an EU-level deposit insurance programme in place to assure depositors that their money would be safe. Then there definitely would be no run on European banks.
But popular sentiment in Germany and the Netherlands that it would be the Germans and Dutch who would wind up paying for the deposit guarantee scheme won the day. This plays right into the hands of Mr Trump, who is adopting a divide-and-conquer strategy against the EU. Although the Germans and Dutch are unwittingly acting as Mr Trump’s allies in Europe, his real friend is Matteo Salvini, the Italian interior minister and leader of the far-right League party, whose not-so-secret agenda is to take Italy out of the euro and the EU. He is also an admirer of Russian president Vladimir Putin — and is not shy about saying so.
What might be termed “populist hazard” has become more of a threat to German and Dutch interests than moral hazard, though the monetary hawks in both countries do not seem to have caught on yet.
Mr Trump, who is a big fan of Brexit, would be an even bigger fan of “Italexit”. But the EU should not make things easy for Mr Salvini. Brussels must re-build trust in the EU and support for the euro in Italy. It should make the case that membership of the bloc does not only mean pain for ordinary Italians, but also safety, support and reassurance. If Italian households felt more secure about their bank deposits because of EU-level insurance, they would be less susceptible to the siren song of populism.
Besides, EU-level deposit insurance is sound economic policy. A monetary union without unified deposit insurance is not sustainable. The US understood that during the Great Depression, when, in 1933, Congress established federal deposit insurance to stop bank failures. Both policies are very much in the German and Dutch interests because they work to keep Italy in the euro and the EU at a time when its populist leaders are looking for an excuse to take it out.