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Article / 11 October 2017 at 10:05 GMT

Weekly Bond Update: Forget Catalonia, Italy is the real risk

Fixed income Specialist / Saxo Bank

  • Bond investors clearly remain bullish on Spain 
  • Catalonia alone against the world is not credible
  • Catalonia is camouflaging the real worry – Italy
  • Italian banks will be very stressed by ECB QT 
  • Italian financial system is vulnerable to messy politics


 We're all captivated by Catalonia but Italy should worry us more. Pic: Marcell Faber /

By Althea Spinozzi

A lot of Europeans spend their summer vacations in Spain, many have even bought second homes there and spend cold winters thinking about their return to the land of sun, paella and sangria. Nevertheless, two million voters in Catalonia think they would be better off outside Spain, and not only has their act of protest been watched closely worldwide it has cast doubt on the European Union itself.

Bond investors have carefully monitored developments, wondering what would happen to bonds should things escalate. This question can be answered by looking at last week’s bond yield movements as the market positioned itself for a possible “Catalexit”.

Monday last week, the day after the independence vote, the yield on Spanish 10-year bonds opened 8 basis points higher, reaching its peak on Wednesday when it touched 1.76%, a total widening of 16bps compared to the previous week's close. Even though market sentiment was particularly negative at the beginning of last week, the Spanish government decided to go ahead with the placement of new 5-year and 10-year notes. 

Surprisingly, the issuance of new debt was well received by the market. Spain 6% 2029 was placed with a yield of 1.867% and a bid-to-cover ratio of 2.5 while Spain 0.45% 2022 was placed with a yield of 0.53% and a bid-to-cover of 2.12. This is a clear sign that investors remain bullish on Spain regardless of what’s happening in Catalonia as they believe the region lacks what is required to become independent.

In extraordinary situations such as this, yields on subordinated debt normally shows the largest fluctuations. However, if we look at notes from Santander and BBVA, the two biggest Spanish banks by assets, we can see that their subordinated debt yields widened by between 10bps to 20bps just after the independence vote, but quickly tightened back as risk waned. Subordinated bonds from CaixaBank and Banco de Sabadell, which have large exposure to Catalonia, were the most badly hit and closed last week approximately 35-40 bps wider, but in the past couple of days they also started to perform as the threat of independence started to fade. 

Even though both banks have large exposure to the region they have spent the past few years in trying to mitigate political risk via expansion within the Spanish domestic market and abroad. Should the situation get out of hand, they are now both in a position to move their legal headquarters from Catalonia to Spain should this become necessary. If this were to happen it would put the very heart of Catalonia’s independence movement under stress as it would mean the loss of some of the region's biggest taxpayers.

In this context, the bigger loser is actually Catalonia. Generalitat de Catalunya 4.95% 2020 widened +90bps last week and now offers +320bps over the Spanish curve. This is a clear sign that if Catalonia leaves Spain, yields would generally suffer but it would be the smaller regions that would pay the highest price.

It seems that investors are not taking Catalonia’s threats seriously at the moment. It is indeed hard to believe that such a small region has all the requirements to form a political apparatus able to carry out independence negotiations with both Spain and the EU. And maybe this is what separatists need to know: Catalonia alone against the world is not credible.

Why Italy is a worry

The truth is that Catalonia is camouflaging what investors should really be worried about – Italy. The country is highly indebted with a total deb- to-GDP of 132.5% with only Greece and Japan having higher ratios globally. The Italian economy is underperforming with a sluggish GDP growth. This year’s quarterly results for Q1 and Q2 were around 0.5% and 0.3% respectively and many doubt it will be able to tick above 1% by the end of the year. Non-performing loans are all over Italian banks’ balance sheets as they are not able to write off much of that debt and the European Central Bank is not properly addressing this problem. On the top of it, when the unwinding process of loose central bank policies begins, the Italian economy will be put under further stress, possibly triggering a financial crisis.

The situation becomes even more tragic when one looks at the country’s political situation. There is growing support for the populist anti-EU Five Star Movement which promises to renegotiate treaties with the EU if they are elected in May next year.

Italian 10-year BTPs pay a yield of 2.11% which is only 45bps higher than Spain. Italian banks hold approximately 20% of all Italian government bonds meaning that not only they have a weak balance sheet they are also highly exposed to Italian government debt, making the financial system even more vulnerable to a potentially messy political situation.

five star

No joke. Five Star Movement founder Beppe Grillo is a very real threat to Italy's financial system. Pic: Antonio Nardelli /

The current situation in Spain is a good starting point in order to understand what would happen in the bond market should volatility start to pick up in Italy. The problem is that an increase in yields would not be as benign we have seen in Spain. As we will get closer to elections, the Italian curve will get softer and if election results were to show substantial support for the anti-EU establishment, there would be a considerable widening of Italian yields that would put pressure on the Italian financial system. If on the top of that the ECB were to follow through with hawkish policies this would push yields even higher.

The combination of an underperforming economy, a weak banking system and growing support for a populist political party make the Italian situation highly explosive. Are investors truly pricing this into bonds?

– Edited by Clare MacCarthy

Althea Spinozzi is a sales trader at Saxo Bank

fxtime fxtime
Catalonia will find independence will be too expensive IMHO as has Scotland as the Euro Union have stated to Scotland that independence does not mean automatic membership into the EU. Any independent state needs to comply and evidence the new nations ability to maintain fiscal prudence etc. Greece has taught the EU about due diligence and thus Catalonia like Scotland will not have automatic free access to EU markets.
kalish kalish
how is it possible to have a 0.5% Q1, a 0.3% Q2 and not be above 0.1% over the year? I would like someone to explain me that.
kalish kalish
pardon me, typo, 1% over the year. Still in need of an explanation.
Market Predator Market Predator
Yesterday's exhibition of Catalonian PM was tragedy! It's like Mr. Carney from BoE regarding strictly no-hike and next day opposite :)
BTW: MP is happy to have you in morning call, Lady. I wonder if you're Italian as origin. Am I right? I like the way you speak English, it's clear for me to understand You. Wish you all the best at Saxo :)
Antonio Migliaccio Antonio Migliaccio
The forcast for italian gdp is 1.2% y/y are you sure mega global sales?
Althea Spinozzi Althea Spinozzi
Thank you all for your comments. Italian GDP consensus at the moment is above 1%, however GDP figures are just one side of the story. Political uncertainty, a huge debt burden and a weak banking system with large amounts of toxic debt make Italy the perfect playground for a crisis.
Althea Spinozzi Althea Spinozzi
@marketpredator: yes I am Italian and I am the one holding the fixed income morning call in the morning, thank you very much for your good wishes!


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