Italian Bonds in Tailspin Only Get Worse as EU Leaders Squabble

(Bloomberg) -- Each day without a euro-area consensus on a rescue package for the embattled economy, Italian bonds grow ever more vulnerable to the risk of rating downgrades.

The securities swung between gains and losses after European leaders gave themselves another two weeks to agree on a long-term response to the coronavirus crisis, heightening fears about the economic devastation facing the region’s more vulnerable economies. Benchmark 10-year yields headed for a fourth straight weekly jump on concern that S&P Global Ratings could take the nation closer to junk status Friday.

At a video conference on Thursday, European Union leaders differed on how to jointly finance a recovery package for struggling economies, of which Italy is among the worst. While an Italian syndicated bond sale drew unprecedented demand earlier this week, it was also a stark reminder of the nation’s steep funding needs as it faces the threat of losing its investment-grade rating.

“It is clear that more EU or euro-area risk-bearing decisions are needed to keep confidence in Italy alive,” said Jan von Gerich, chief strategist at Nordea Bank Abp. “That said, when the price is right, there is still plenty of private demand for Italian bonds,” he added, referring to this week’s bond sale.

Italy’s debt markets are on life support from the European Central Bank’s bond-buying program, which has helped reverse some of the panic sell-off seen last month when the scale of the virus’s impact on the economy was becoming clear. That hasn’t stopped the bonds from falling, although it may have eased the pace of declines.

The ECB is keenly aware of the risk Italy may soon join the ranks of so-called fallen angels, having said this week that it will accept junk debt as collateral for loans. S&P currently rates the Mediterranean nation at BBB, two notches above sub-investment grade, with a negative outlook.

‘Broadly Unaffected’

Still, some positive news came from Moody’s Investors Service, which ranks Italy at the lowest investment grade -- the credit assessor hinted that it will refrain from cutting the nation to junk at a scheduled review on May 8.

“Although the coronavirus pandemic is leading to a severe economic shock that will push Italy’s public debt to record levels this year, the country’s creditworthiness should remain broadly unaffected given the temporary nature of the downturn and continuing low funding costs,” the ratings agency said in an April 23 statement on its website.

Yields on Italian 10-year debt jumped by as many as 12 basis points in early trades Friday to 2.10%. The market reversed direction later, pushing the yields down by 10 basis points to 1.89% as of 1:36 p.m. in London -- but they were were still on track for a 10-basis-point climb on the week.

That puts the nation’s bonds on course for the longest weekly losing streak since November. The spread over German equivalents narrowed about six basis points on the day to 235, after widening to as much as 257 basis points earlier.

The ECB is set to meet next week amid speculation that the institution will have to expand its latest asset-buying plan -- the 750-billion-euro ($807 billion) Pandemic Emergency Purchase Program. President Christine Lagarde sees the region’s economy shrinking as much as 15% this year, having warned EU leaders Thursday that they had done too little, too late.

While EU leaders endorsed a short-term 540 billion-euro plan to support businesses and economies from now, a longer-term rebuilding program proved elusive with member states split on how to spread the financial strains.

“I don’t think yesterday’s meeting was ever going to be the final word on this, it was always just the next step in the process,” said Imogen Bachra, a European rates strategist at NatWest Markets. “I think Italy avoids a downgrade tonight.”

Traders of Italian bonds will be watching to see if German Chancellor Angela Merkel’s rallying call to back a huge stimulus package will spur other leaders into action. Meanwhile, the government in Rome approved an economic and financial plan of its own in cabinet meeting, according to official who asked not to be named in line with policy.

“The bottom line is that barring a more ambitious deal, the ECB is likely to remain the only game in town as far as peripheral spreads are concerned,” said Frederik Ducrozet, global strategist at Banque Pictet & Cie in Geneva. “Chances are that the ECB will be under mounting pressure to increase the size of its PEPP program to at least 1 trillion euros by June, if not earlier.”

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