Idea of the Day: Warming on Italy

There’s always something to love about Italy in August, but it’s not usually the economy. However, a recent run of decent economic data, including industrial data and the service sector PMI for July, which reached its highest ever level, has made investors stand up and take notice.

What: There’s always something to love about Italy in August, but it’s not usually the economy. However, a recent run of decent economic data, including industrial data and the service sector PMI for July, which reached its highest ever level, has made investors stand up and take notice. There are the fundamentals of a strong economic recovery story emerging in Italy, and it could have further to go.

Aside from the economic data, there have been other factors that have brightened Italy’s outlook, including a positive surprise in earnings for Unicredit for Q2, it reported profits of EUR 945mn and reduced further its exposure to non-performing loans. This suggests that the stronger banks in Italy may be past the worst after last year’s scare when Monti di Paschi required a state sponsored bailout.

Sovereign risks have also receded, the Italian 5-year CDS spread has fallen to its lowest level since 2009, suggesting that sovereign default fears have fallen sharply. This is also reflected in the spread between Italian and German bond yields, which had lagged behind Spanish and Portuguese yield spreads, but as you can see in the chart below, Italy has started to play catch up.

How: We believe that this suite of good news for Italy could trigger further gains in the FTSE MIB, the main Italian stock index. This index is close to its highest level since May, when the index faltered at 21,828. Today’s data boost could see the market clear this significant resistance level, which would open the way to further gains towards 22,000 and beyond.

A strengthening Italy, especially its banking system, also reduces the pressure on the ECB to maintain a very loose monetary policy stance. We have mentioned in previous posts that for EUR/USD to continue its march higher then the ECB needs to at least talk about reducing stimulus, something it has avoided so far. If Europe’s weakest link is improving then the ECB may have the confidence to talk about a taper of its APP programme potentially at this month’s central bankers’ conference in Jackson Hole, which could be enough to trigger further euro strength, especially vs. the USD, JPY and GBP.

Chart 1: Eurozone yield spreads, Italy playing catch up 


Source: City Index and Bloomberg 

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