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During his eight years as president of the European Central Bank, Mario Draghi developed an almost mythical ability to control borrowing costs by eurozone governments. Investors seem to be recognizing similar powers to the Italian prime minister, given the calm that has fallen in the region’s bond markets since he took office in February.
Italian bond prices soared and reduced borrowing costs as Draghi shifted from being a much-credited former central bank to becoming a eurozone debt crisis politician a decade ago. After a brief whirlwind in recent weeks, when investors were keen to start removing emergency stimuli from the ECB, Rome’s borrowing costs have returned to a one-month low.
Analysts at Goldman Sachs have said the former ECB chief’s power in bond markets has “put Draghi”. “Prices of Italy’s sovereign risk indicate confidence in Draghi’s ability to take political risk,” the bank wrote in a note to customers last week.
Investors have backed the prime minister’s plans to overhaul the Italian bureaucracy while spending 205 billion euros on EU recovery money. Italy’s 10-year ultra-safe German bond interest rate is the most important stretch that Italy pays for its debt by more than one percentage point, not far from a five-year surplus in February.
“There’s definitely a view that Draghi can’t go wrong in the market, that everything he touches turns to gold,” said James Athey, a bond manager at Aberdeen Standard Investments.
Some fund managers feel the possibility of shaking Italy out of a decade of low-growth corporation. The stability provided by Draghi’s national unity coalition is betting on an ideal backdrop for the reform program, as Italy deploys one of the largest shares in the EU’s 750 billion-euro pandemic recovery fund. The government has put in place a watchdog to oversee the payment of money, and has put in place measures to ease bureaucracy and speed up infrastructure development.
“That’s what Italy needs to do in the longer term. It’s aimed at fiscal spending focused on appropriate reforms,” said Gareth Colesmith, head of global tariffs at Insight Investment. “That’s why we’re positive with Italy.”
The direction of Italian expansion has an impact outside its borders. As the largest eurozone government bond market – and one of the most risky – Italy sets the tone for high-risk assets across the bloc. So far, the “Draghi Effect” has helped clear concerns about a significant public debt of more than 160 percent of Italy’s GDP, according to Andrea Iannelli, investment director at Fidelity International.
Iannelli says that can be too optimistic. Plans are one thing, but channeling billions of investments can spark old political conflicts. There are some signs of disagreement among voters, after the Italian brothers against the EU – the only major party that does not support the Draghi coalition – now consistently win second place in national elections.
“It’s not going to be an ordinary sail,” Iannelli said. “And plain sailing is something the market has valued.”
As it is a technocratic appointment, Draghi does not expect to continue as prime minister beyond the next election. The coalition’s term is set to end by 2023, although the vote will come as soon as next year if Draghi decides to run for the Italian presidency.
Chiara Cremonesi, a fixed-income strategist at UniCredit, said markets will soon begin to worry about what might follow the union coalition. “Investors are positive with Draghi, so obviously they are worried about how long his government will last,” he said. UniCredit does not expect an election in 2022, but “increasing political noise” could boost the expansion to a level of about 1.2 percentage points achieved before Draghi arrived.
Despite no political outcry, the relative calm in the markets depends on the ECB and continued support for the markets through the 1.85 million euro pandemic bond purchase program, which Draghi’s successor has included Christine Lagarde in the central bank. The sale of eurozone bonds in May boosted Italian expansion and also lifted German yields. This shows which sensitive markets suggest the initial “reduction” in transport purchases from the current rate of 80 billion euros per month.
Since then, a succession of ECB officials, including Lagarde, has reassured investors that he will continue his efforts at this month’s policy meeting. Investors believe that the ECB will be very sensitive especially to the rise in Italian yields. While the former head of the ECB remains in office, some are betting that the central bank will have more chances to keep the stimulus taps running.
“As long as they believe Italy is making sensible reforms, they will continue to provide support,” Colesmith said.
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