SocGen: Dump Italian Government Bonds, And Buy Spanish Ones

In the wake of the Italian election -- which looks likely to end with an unstable government, at best, SocGen is advising clients to sell Italian bonds, and buy Spanish ones instead.

Says analyst Ciaran O'Hagan:

We expect an unstable coalition will materialise in April. But it will be unable to take the tough measures which are needed to facilitate a pick-up in Italian growth. That scenario will be rewarded with rating downgrades. More worryingly still, this will be set against the difficult budget negotiations in the US, and the dénouement of the Cyprus mess. In the meantime, the Washington brinkmanship is likely to further exacerbate tensions in Europe.

That is of course exactly what we saw in 2011 (i.e. BTPs were hit badly by the contagion of US risk). Two years ago on Friday 5 August, the US was downgraded by S&P; that was the last straw for the ECB, leading the ESCB to buy BTPs and SPGBs on Monday 8 August.

A better horse to ride now is still SPGBs. Spain has proved more resilient to stress: it is of course easier now for Spain (than Italy) to ask for help. And ECB/ESM buying would resteepen the SPGB curve vs BTPs.

This key point about who can or can't ask for ECB help is key.

One of the primary messages from the Italian election is that voters don't like politicians who take their cues from Brussels or outside leaders.

In order to get ECB purchases of your sovereign debt, you must not only ask, you must submit to outside-imposed austerity conditions. Italy just rejected this option. Spain more easily maintains this ability.