Italian bond investors gear up for big test as debt auction looms
As financial markets brace for a clash between Rome and Brussels over the coming budget, some are pointing to a debt auction on Thursday as a litmus test of whether investors will continue to snap up on one of the highest yielding government bonds within the eurozone.
A fresh influx of Italian debt supply may be ill-timed for investors who have balked at the new Italian governmentâs strident rhetoric on fiscal easing, a development that has troubled the European Union and credit ratings firms. Though, the recent selloff has helped to cheapen the countryâs bonds, their weakness reflects growing concerns that the Italian government will follow through with an unrealistic 2019 budget outline which will widen the deficit in violation of the EUâs strict fiscal rules.
âIf yields donât decline, then auctions will remain in the line of fire,â wrote analysts at SociÃ©tÃ© GÃ ©nÃ©rale.
The 10-year Italian bond yield TMBMKIT-10Y, +0.00% traded at 3.507% after climbing to a four and half year high of 3.710% earlier on Tuesday, according to Tradeweb data. Bond prices move in the opposite direction of yields.
Italy is expected to sell more than 6 billion euros ($6.90 billion) of government paper on Thursday. Including the current batch of auctions, Italy will issue another 56 billion euros of debt before the end of 2018, according to SocGen estimates.
Despite the higher yields, its unclear whether investors will express appetite f or Italian paper. Demand has already softened since the antiestablishment government took office in the March election. Net foreign selling of Italian securities totaled more than 70 billion euros in May and June alone, data from the European Central Bank show.
And support from the ECB has diminished. With the ECB slated to end its bond purchases this year, its buying of Italian debt will be trimmed on average to 1.6 billion euros a month from October to December. Quantitative easing has helped to mute volatility and bolster prices for government debt of economies like Italy and Spain, viewed as peripheral members within the eurozone bloc where Germany is the core constituent.
See: Italyâs budget dilemma may complicate ECBâs attempt to wind down QE
âThe continued assurance that the Tesoro can refinance itself with ease is fundamental for rating agencies,â the SocGen analysts said, referring to the Italian Ministry of Economy and Finance .
Ratings firms have circled around Italy, with investors expecting an imminent downgrade from Moodyâs Investors Service. That would bring the credit rating of the third-largest economy in the eurozone one step closer to a so-called junk rating, a move that would put it out of reach of conservative institutional investors barred from holding below investment-grade debt.
Hopes remain that Italian Finance Minister Giovanni Tria could temper the deficit-widening urges of deputy prime ministers Matteo Salvini and Luigi di Maio, heads of the League and 5 Star Movement. A conciliatory figure for financial markets, Tria has sought to reassure investors this budget outline wonât put the Italy government on an unsustainable fiscal trajectory, but some investors fear his position has been eroded after he promised a budget deficit lower than 2% of the gross domestic product, before buckling to a deficit number of 2.4%.
Reuters reported politicians in the coalition ma y be seeking the resignation of Tria.
And bond yields are edging toward a level that raises concerns about the overall health of the Italian banking system. Though well-capitalized, Italian lenders like Intesa Sanpaolo SpA ISP, +0.53% and UniCredit SpA ISP, +0.53% have a hefty exposure to the countryâs government paper, with such holdings estimated at around 10% of the total banking systemâs assets, the Wall Street Journal reported.
Read: Hereâs why investors remain uneasy about Italyâs banks and the âdoom loopâ
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