News in Charts: Italy – Europe’s safe haven?

Following last year’s general election — which resulted in a hung parliament and a populist coalition (see ‘Italy – the relative calm after the storm’) — Italian debt sold off with yields peaking at 3.6% after the new government drew sharp criticism from the European Commission for its proposed budget that risked breaching EU rules. In recent weeks the Commission has softened its stance on Italy and reached a compromise with the government. This, together with hints of a more dovish stance at the ECB, have pushed Italian yields lower.

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Fathom’s Sovereign Fragility Index (SFI) provides an objective assessment of the fundamental, macro-driven risk of sovereign debt across several major developed and emerging economies. According to the SFI, Italian spreads have remained largely unchanged since 2014 at around 1.2 percentage points, far below the current market spread. The SFI thus suggests that the recent narrowing in spreads could continue.

Indeed, investors appear to be overestimating the riskiness of Italian debt relative to fundamentals. While fundamental macro variables do not capture political risks and other uncertainties which are picked up by the market, Italy’s SFI ranks (perhaps surprisingly) among the safer euro area economies.

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Investors may be too quick to look at the size of Italy’s government debt ratio, which lies north of 130% of GDP and ranks second only to Greece in the euro area. However, it is not just the level of debt that matters for sovereign risk, it is also the composition of that debt. On this measure, Italy looks relatively favourable with domestic residents holding a large share of the sovereign’s liabilities.

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This is not to say that Italian debt presents a safe haven within Europe, far from it. Factors other than macro fundamentals matter too, not least political risks, which could lead to policy change. These can, over time, cause yields to deviate from the levels implied by fundamentals with deviations able to last for years. In Italy, this is visible not just in the past year, but also following the collapse of the Renzi government in 2016 and during the heights of the euro area crisis.

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The charts in this article have been created using Chartbook on Datastream. The Chartbook was initially created by Fathom Consulting in 2012 and is now a catalogue of approximately 9000 charts, covering over 170 countries, analysing up-to-date macro and financial data. Whether it is a particular topic, country or variable you are interested in charting, the Chartbook has everything you need. The Composite FVI, comprised of readings from all four underlying FVIs, is available for 176 countries in the Fathom Proprietary Indices section of Chartbook. To access Chartbook via Datastream search ‘cbook’.