Deep Thoughts on Rome's Successful 20-Year Bond Auction

Amid another round of political upheaval—not to mention a global freakout over a potential Quitaly—Italy sold a 20-year bond Wednesday. This, in and of itself, should not be news. Countries sell bonds all the time. But demand for this bond was four times the amount on offer, which is huge. Some headlines couched this as a dangerous sign of yield-starved investors voluntarily overlooking risk. Yet we see this as a sign markets, always forward-looking and efficient, are quite good at separating news from noise.

Italy’s Treasury offered €6 billion worth of this new bond, which matures in 2040 and has an annual coupon of 3.1%.^[i] When banks shopped it, investors put in bids totaling around €24 billion, for an average yield of 3.15%. This tells us a couple things: One, Italy’s government is more than capable of funding itself, despite the debt sirens’ warnings. Two, investors are able to see through said warnings, assess the likelihood that Italy will be a fully functional eurozone member-state capable of servicing its debt in 2040, and calculate how much compensation they require for the risk of a 20-year loan. In this case, it was only five basis points more annually than the government initially offered.

We guess it is possible this is a case of investors ignoring obvious risks—in the sense that anything is possible. But some recent historical context suggests this is unlikely. As last year showed, investors weren’t shy about demanding more compensation from Italy’s government when they sniffed higher long-term risks. The entire eurozone crisis is a testament to this as well. Even German bond auctions were undersubscribed then. Are we really to believe extreme pessimism has spiraled into unwarranted euphoria today? Particularly when headlines remain mired in doom? Even broad complacency towards eurozone “risks” looks highly unlikely considering surveys routinely show investors are pessimistic toward the region’s stocks. Inflation may be a big bond yield driver globally, but default risk matters country to country. If Italian default risk were legitimate, yields would almost surely show it.

Maybe, just maybe, this is a case of investors thinking rationally—not irrationally. Maybe they have contrasted the headline freakout over the potential Italian parallel currency known as the “mini-BOT” with the Italian Treasury’s actual statements on the matter, read up on the history of nonbinding parliamentary motions ever becoming law, and decided it is a tempest in a teapot. Maybe they have followed Deputy Prime Ministers Luigi Di Maio and Matteo Salvini’s nonstop squabbling with each other and their own prime minister and decided this populist government is unlikely to last long—and even less likely to do much while it remains in power. Maybe they see how wrong headlines have been about populists in Italy and throughout the eurozone for years and see a high likelihood that reality isn’t different this time. To argue any of these explanations must be incorrect is to argue markets aren’t very efficient and are ignoring issues headlines have spouted for well over a year now. In our experience, that is almost always a losing proposition.

When in doubt, trust the market. It is much better at pricing risk than headlines and pundits are.