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Ferrari or Italy – Which Is More “Risk Free”?

The concept of a risk free-rate, or the yield of government-issued securities, has long been one of the fundamental building blocks of capitalism and the basis of modern financial literature. It is a concept so intuitive that the general investing public in much of the developed world has largely taken for granted, both academically, and in most cases, in practice. After all, governments have the power to tax, and to print money, therefore it is hard to imagine a government which can default, particularly in developed countries.

Although governments have defaulted in past era’s over war and famine, contemporary wisdom started to show signs of cracking starting from the GFC in 2008, and more recently, in debt-burdened Western Europe. As was the case during the Greek crisis, the risk-free rate does not at the moment seem that risk-free after all.

What happened in the last couple of weeks in Italy serves as a good example of exactly this. As at 7 June 2018, the Italian supercar maker Ferrari’s 2023 bond, not currently rated by any of the major ratings agencies, carries a yield of 1.29%, lower than the 2.17% yield paid by an Italian sovereign bond that matures earlier than this date (Figure 1). A 2024 bond from Luxottica, owner of Ray-Ban sunglasses, currently yields 0.72%, less than a third of Italy’s six-year sovereign borrowing cost of 2.45% (Figure 2).

Figure 1: Italian Government vs Ferrari

Source: BondAdviser, Bloomberg

Figure 2: Italian Government vs Ray-Ban

Source: BondAdviser, Bloomberg

The implications are simple: The market believes that the Italian government is of more risk to credit investors than a car manufacturer or a sunglasses maker. To put this in more perspective, Italian 10-year sovereign yields are currently more than 200 bps (2.00%) higher than Germany’s, the healthiest of the Western European states.

We are not inclined to pen a thesis on the rather peculiar picture in Italy – after all, it is a frontline symptom of the complex social, political and economic developments that have been occurring in much of Western Europe. But, putting it simply, if we view the Italian government as a car company that competes with Ferrari for bond investors’ money, then the former clearly has seen its sales stagnating (Figure 3), and its debt reach almost unacceptably high levels (Figure 4).

Figure 3: Italian Growth vs Peers

Source: BondAdviser, Eurostat, AMECO European Commission, national statistics offices

Figure 4: Italian National Debt (% of GDP)

Source: BondAdviser, Eurostat, AMECO European Commission, national statistics offices

Back home, to our collective relief, Australia’s stellar economic performance since the end of the Second World War has been nothing short of outstanding compared to developed peers. Not surprisingly, the Australian financial market has exhibited more textbook behaviours, i.e. the risk-free rate has been truly risk free, yielding the lowest spreads and forming the foundation of Australian corporate bond yield curves. After all, Australia has never experienced a banking or government debt crisis anywhere remotely resembling the ones afflicting many European countries. The credit ratings of the Australian government have remained at the best-possible triple-A by all major agencies and we have yet to see an Australian corporate borrower able to borrow at lower rates than the Australian state.

As the royal commission looks set to uncover more past complacencies in the local banking sector, we are confident that it will only strengthen the sector in the long run, albeit with some probable short-term pain. For many reasons, we are highly unlikely to see a car or sunglass manufacturer achieve better debt pricing than the commonwealth.