Italy country-specific exchange traded funds weakened Friday as hedge funds’ bearish bet against Italian bonds reached levels not seen since the financial crisis.
On Friday, the iShares MSCI Italy Capped ETF (NYSEArca: EWI) declined 2.7% and Franklin FTSE Italy ETF (NYSEArca: FLIY) decreased 4.2%.
Italian markets have been retreating in this year, and observers grew increasingly bearish in recent days on fears that Italy’s likely new anti-establishment coalition government will add to the country’s debt pile and potentially loosen ties with the European Union, the Wall Street Journal reports.
For instance, Alan Howard, the secretive billionaire co-founder of hedge fund firm Brevan Howard, has been betting that Italy’s borrowing costs will rise relative to Germany’s, said two people familiar with the fund’s positioning.
Yields on 10-year Italian government rose to 2.538% Friday, their highest level since 2014, with spreads compared to German debt widening above 2 percentage points for the first time since June 2017.
Italian Stocks Dragging
Italian banks were among the worst off in European stock markets. Financials make the largest portion of the Italy-related ETFs, accounting for 33.5% of EWI’s portfolio and 35.8% of FLIY’s underlying allocations.
Investors have also grown more wary of Italy’s outlook as the European Central Bank slowly cut back its stimulus that supported Italian and other E.U. members’ debt.
“QE has destroyed any sense of risk in the sovereign bond market and we may be due for a very rude wake-up call once the dust settles,” Joseph Oughourlian, founder of London-based hedge fund Amber Capital, told the WSJ.
Additionally, political risk has contributed to the increased volatility. Italy’s election in March gave two anti-establishment political parties a parliamentary majority. Investors were particularly concerned over a leaked draft agreement between the two parties that included proposals to write off debt and increase spending. However, the debt proposal was later abandoned. The two parties have shown an intent to review “the economic governance infrastructure of Europe” and even flirted in the past with the idea of Italy leaving the eurozone.
“What’s most troubling is that markets haven’t yet woken up to this major political risk,” Oughourlian added.
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