Italy Faces 50-50 Risk of Being Downgraded by S&P, Deutsche Says

(Bloomberg) -- Whether or not S&P Global Ratings downgrades Italian debt this week is a coin toss, according to Deutsche Bank AG.

“We think it’s a 50-50 call as both an unchanged outlook as well as a downgrade could be justified,” wrote Ioannis Sokos, a strategist at Deutsche, citing S&P’s outlook criteria from April.

Sokos recommends so-called flatteners in the 10- to 30-year part of the Italian curve, versus Germany’s equivalents, in case the nation’s rating is lowered from BBB. Should it come to pass, S&P would be the third major rating company to hold Italian debt at one notch above junk status, a level that would push it out of key bond indexes.

Since a dramatic selloff in March, Italian debt has been supported by the European Central Bank’s bond purchases and the prospect of an unprecedented pandemic rescue package by the European Union. Still, with a debt-to-GDP ratio of close to 160%, the economy is one of the region’s most indebted and remains vulnerable to any set-backs to the growth outlook.

The scale of the market reaction to a potential downgrade will depend on whether investors lighten their positions ahead of the decision this week, and on the ECB’s “willingness to actively fade a potential widening move, ” Sokos said.

On Monday, the yield on 10-year bonds rose seven basis points to 0.72%, almost 10 basis points above a record low it touched last week. That’s pushed the spread over their German peers to 132 basis points, the widest level since early October.

In its latest review, S&P said it could lower Italy’s rating if government debt-to-GDP “fails to shift onto a clearly discernible downward path over the next three years, or if there is a marked deterioration in borrowing conditions that jeopardizes the sovereign’s public finance sustainability.”

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