The budget season is about to start and by the end of September the key parameters of the 2019 Budget will be revealed. We maintain our view that the 2019 deficit will not exceed 2.5% of GDP, and in fact it is likely to barely touch 2% of GDP next year given the very effective internal and external fiscal rules that Italy has. Anybody that is afraid of “excessive spending” is looking in the wrong direction. As a result, the 10 year bond yield trading above 3% appears to us as a good buying opportunity as long as you accept that volatility is unlikely to moderate any time soon.
According to the balance of payments data released by the ECB, Italy saw a second consecutive month of large capital outflows via the portfolio investment item (bonds and equities), worth EUR42bn in net terms in June. This was the largest monthly portfolio outflow of the last 10 years. However, it was matched by EUR44bn of capital inflows in the “other investment” segment, which reflects various items including central banks’ operations and multinationals activities to boost or withdraw liquidity from their subsidiaries via deposits, loans and trade credits. These two segments needs to be observed in tandem, because what we maybe observing is not necessarily a clear capital outflow from Italy, but a readjustment of they type of financial instrument exposure. In fact, if we take a three-months rolling sum, quite the opposite appears: overall the country in May and June has seen greater equilibrium between portfolio and other investment flows, compared with a period between June 2017 and April 2018 where there was a net capital outflow from portfolio and other investments together. The data show quite a lot of seasonality since 2013 so in our view nothing bolder can be drawn from this data other to say that Italy overall remains an “exporter” of capital and its competitiveness improvements are not sufficient to turn around this trend. The chart below shows a thin blue line, which is the series that was widely reported by the press on bond holders “exodus”, while the thick blue line shows the sum of other and portfolio investments, on a 3 months rolling basis, both in EURbn.
On the other hand, Italian equities in our view have further downside risk ahead as the political rhetoric will remain confusing to most, the upcoming corporate tax changes will likely benefit micro and small companies initially (due to the budget constrains) and publicly-influenced companies are likely to be nudged towards greater investment next year.