By Steven Levine, Senior Market Analyst, Interactive Brokers

Italy’s massive amount of sovereign debt has helped keep the country’s credit rating on the cusp of junk status, while political uncertainties and a fragile financial sector have served as strong headwinds.

The nation’s domestic policy challenges, its strife with the fiscal rules of the European Union, as well as other structural concerns, have generally eaten into its economic landscape, hampering its future growth prospects.

Fitch Ratings analysts Douglas Winslow and Michele Napolitano recently noted that Italy’s GDP growth has “stalled as domestic policy uncertainty and weaker external demand has dragged down investment, while private consumption growth has also lost momentum.”

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Fitch’s outlook for GDP growth for 2019 dropped to 0.3% from 0.8% in 2018 -- and much lower than the 1.2% it expected for both years at its previous review in August, with investment growth having fallen to 0.4% from 3.8% last year.

The ratings agency also anticipates an increase in general government debt to 132.3% of GDP in 2020 from 131.7% in 2018, driven by lower nominal GDP growth, and a 0.7pp weakening in the primary balance from 2018-2020. This compares with Fitch’s current 'BBB' median of 38.5% of GDP and would leave Italy as “one of the most highly indebted sovereigns we rate, exposed to downside risks and with reduced scope for counter-cyclical fiscal policy.”

Fitch recently confirmed its ‘BBB’ sovereign credit rating on Italy with a negative outlook – only two notches away on the agency’s credit rating latter from junk status.

Winslow and Napolitano further pointed out that coalition differences and the “absence of a well-defined economic policy agenda in our view contribute to investor uncertainty but also reduce the
likelihood of a more far-reaching reversal of structural reforms.”

Against this backdrop, business confidence has weakened, manufacturing conditions have deteriorated, the rate of inflation has decelerated, and political dominance appears to be shifting.

According to a Reuters report Monday, Italy’s center-right party appeared set to cement a win in a regional vote in Sardinia, which could pose a threat to the populist 5-Star Movement, part of the ruling coalition in Rome, amid European Parliament elections in May.

Meanwhile, Italy has entered its second recession in four years after its economy contracted by 0.2% in the fourth quarter of 2018 following a -0.1% slowdown in Q3 ’18.

Ron Quigley, head of fixed income syndicate at Mischler Financial, pointed out that the BTP is yielding 2.877% or +2.775 compared to Germany’s Bund. He also noted Italy is the world’s #3 debtor nation, and the EU’s third-largest economy, with Italian banks holding roughly US$215bn in equivalent non-performing loans, more than any EU nation.

In intraday trading, Monday, the yield on Italy’s two-year government debt was around 10bps tighter at just over 0.4% and its 10-year BTP was a little more than 5bps tighter at about 2.790%, following Fitch’s rating announcement.

Some five-year credit default swap (CDS) spreads in the country’s banking sector also narrowed on the day Monday, including Intesa Sanpaolo (OTC: ISNPY) and UniCredit (OTC: UNCRY), which tightened more than 4bps and 4.5bps, respectively.

Economic activity in the week ahead will shine more light on Italy’s economic health, including updates on consumer and business confidence, CPI, manufacturing, unemployment, and GDP.

The week kicks off in earnest:

Tuesday, February 26

• Treasury Bill Auction – 6-month BOT

Italy’s Treasury is set to auction six-month bills due August 30, 2019. The bills, which were announced February 21, are scheduled to settle February 28.

By mid-week:

Wednesday, February 27

• 5- and 10-year BTP Auctions
• Consumer Confidence (Feb)
• Business Confidence (Feb)

The country’s Treasury will conduct five- and 10-year BTP auctions. The government debt is slated to settle Friday, March 1.

Investors will also receive updates on Italy’s consumer and business confidence for February, after Istat in the prior month reported weaker indices for manufacturing, retail trade, market services, and large-, medium- and small-scale distribution. However, consumer confidence improved somewhat, along with construction.

In January 2019, the consumer confidence index improved from 113.2 to 114.0, but the composite business confidence climate index weakened to 99.2 from 99.7.

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Thursday, February 28

• CPI (Feb)

Meanwhile, Italy Thursday will unveil its rate of inflation for February.

In the previous month, the Italian consumer price index (CPI) for the entire nation increased by 0.1% on monthly basis, and by 0.9% year-on-year, down from +1.1% in the previous month.

Istat noted that the slower annual growth was mainly due to prices of both regulated (from +10.7% to +7.9%) and non-regulated energy products (from +2.6% to +0.3%), partly offset by the acceleration of transport-related service prices (from +0.6% to +2.2%) and, to a lesser extent, of unprocessed food (from +1.3% to +1.7%).

Friday, March 1

• Unemployment Rate (Jan)
• GDP Growth Rate (FY 2018)
• Markit/ADACI Manufacturing PMI (Feb)

Ahead of the weekend, Italy will provide updates on its unemployment rate for January, its pace of GDP growth for the full year 2018, as well as a fresh gauge of its manufacturing sector from IHS Markit.

Manufacturing conditions in Italy deteriorated in January to the greatest extent in five and a half years, due in large part to a steep decline in new orders that led to a quicker decline in output.

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Moreover, IHS Markit said that workforce numbers dropped for the first time in over four years, and selling prices fell for the first time since October 2016.

The headline IHS Markit Italy Manufacturing Purchasing Managers’ Index (PMI) registered 47.8 in January, below the 50.0 no-change threshold for the fourth month running. The reading dipped from 49.2 in December to signal the sharpest deterioration in the health of the sector since May 2013.

IHS Markit economist Amritpal Virdee did note that there was a “bright spot,” as a significant weakening in input price inflation enabled manufacturers to lower selling prices for the first time in 27 months in an effort “to boost sales.”

Against this backdrop, it appears that investors’ perceptions about Italy’s economic and financial well-being Monday likely benefitted from recent reports of progress on the trade front.

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The iShares MSCI Italy ETF, for example, staged an upswing in intraday Monday trading. The ETF holds among its top funds Italian utility Enel, energy company Eni, financials Intesa Sanpaolo and UniCredit, as well as automotives Fiat Chrysler and Ferrari and CNH Industrial.

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