Going by the strength of demand at recent Italian sovereign bond auctions, it would be easy to forget that the government was recently locked in an acrimonious dispute with Brussels over its budget deficit target for 2019. Now that the budget fiasco has died down, investors have been quick to discount further political risk and pickup additional yield.

As the top-left chart shows, cumulative issuance of Italian government bonds so far this year is running above issuance compared to the same period in 2018 (which partially reflects a higher bond auction target for this year). In addition recent bond auctions have been comfortably covered with a syndicated 30-year bond issued on February 6 being over 5x oversubscribed.

Despite the renewed enthusiasm for Italian bonds, we warn that the weak macro picture will increasingly undermine the sovereign debt trajectory. Indeed, with the Italian economy contracting, inflation low and receding, and interest rates elevated, the debt-GDP ratio is at risk of pushing beyond an already burdensome 133%.

(Click on image to enlarge.)

Source: Bloomberg, Macrobond and Variant Perception