UCG Unicredit Spa

By Avantika Chilkoti 

A large rally in Italian bonds is making winners out of the country's banks, whose shaky finances have weighed on global markets in recent years.

Shares of the two largest Italian lenders, UniCredit SpA and Intesa Sanpaolo SpA, have surged almost 7% since the end of last week. Local banks, which have loaded up on the sovereign debt in recent quarters, hold more government bonds than their counterparts in other major European economies. That resulted in the lenders carrying 20.1% of outstanding Italian government debt securities in March, up from 17.5% a year earlier, according to data from Italy's central bank.

Investors piled into Italy's bonds this week, after the government pledged Monday to hit a lower budget deficit in 2019 than expected, helping end a standoff between Rome and European Union authorities. Markets also grew more optimistic about fresh monetary stimulus for the broader region following Christine Lagarde's nomination to lead the European Central Bank.

On Wednesday, the fresh optimism over Italy's public finances precipitated the sharpest single-day drop in Italian 10-year government-bond yields since the peak of the sovereign-debt crisis in August 2011. The yield on these bonds fell Thursday to as low as 1.569% -- a level not seen in more than 2 1/2 years -- after ending the previous week at over 2%, according to Tradeweb data.

The rally in bond prices, which move inversely to yields, has benefited not just the banks, but also fund managers on the hunt for returns amid unprecedentedly low interest rates globally.

"A good part of European assets are in negative territory, which sort of shrinks the universe of positively yielding securities," said Eric Brard, head of fixed income at Amundi, Europe's largest asset manager.

Mr. Brard bought more Italian government debt this year as yields looked increasingly attractive. "You have quite liquid conditions and money looking for places to be put to work."

The gains this week mean Italy's government bonds have recovered all the value lost since early May 2018. The debt was shunned by investors after two populist parties came together to form the government in 2018, with pledges to spend more on welfare while cutting taxes. That put Italy in danger of breaching European Union fiscal limits, triggering speculation about the nation's place in the eurozone and sending shock waves through global markets.

On Wednesday, the European Commission decided that disciplinary action was no longer warranted, following the government's promise to cut the forecast deficit.

"That was really positive for the Italian banks," said Tom Kinmonth, a senior fixed-income strategist at Amsterdam's ABN Amro, who noted that Italian bank stocks have rallied for the past four weeks.

The banking sector's sizable government bondholdings -- which have bolstered the value of their assets this week -- are more frequently a cause for concern among investors. During the last debt crisis, the shrinking value of government debt led to impairment in some banks' balance sheets and curbed lenders' appetite for extending credit to businesses, resulting in a "doom loop" that constrained economic growth.

The easing of tensions helped pare the prices of credit-default swaps, a form of insurance on debt, for Italian sovereign bonds. The annual cost of insuring $10 million of Italian government debt for five years fell to $167,000 from around $200,000 at the end of last week.

Pat Minczeski and Lauren Almeida contributed to this article.

Write to Avantika Chilkoti at Avantika.Chilkoti@wsj.com

(END) Dow Jones Newswires

July 05, 2019 07:44 ET (11:44 GMT)

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