Italy Is Comeback Story of the Year for European Bond Markets

(Bloomberg) -- Investors in Italian bonds are enjoying the best quarter in a year, in a sharp turnaround for one of the euro area’s riskier markets.

The country’s benchmark debt is the region’s best performer for the July-September period and returned over 5% this year, data compiled by Bloomberg show. Yields on Italian 30-year bonds hit a record low this week. That contrasts with a dramatic sell-off in the first quarter after Italy became Europe’s first nation to trigger a nationwide lockdown to contain the coronavirus.

The rally in Italy’s bonds has been underpinned by the unprecedented stimulus unleashed by European policy makers, and the prospect of fiscal support from the European Union. More recently, the market has also drawn support from the political stability that last week’s regional election successes for Prime Minister Giuseppe Conte brings.

Italy’s 10-year bond yield premium over Germany -- a key gauge of risk for the nation -- has fallen to near pre-pandemic levels, even with a resurgence of cases that threatens to upend the fragile economic recovery. The spread is also on track for the biggest quarterly decline in a year.

The Italy-Germany yield differential has also seen the narrowest range in more than two years in the past three months. It’s a sign of investor comfort over the stable political outlook and support from the European Central Bank’s pandemic bond-buying program, otherwise known as PEPP.

Weathering Risk

Thanks to the cushion provided by European policy makers, the Mediterranean nation’s bonds have even managed to withstand a recent worsening of risk sentiment across global markets amid a resurgence of the virus.

Italian long-dated yields have fallen to a record even as the cost of protection against default for Europe’s safest companies rose.

There are still risks though. The EU’s planned 750-billion-euro ($878 billion) economic recovery fund isn’t yet a done deal. If it doesn’t materialize, the delicate balance in Italy’s debt market could be undone.

The European Commission is poised to release a critical report about the state of democracy in Hungary and Poland, which could delay the fund. To compound the problem, virus cases are picking up across the region.

Still, the ECB’s 1.35-trillion-euro pandemic bond-buying program should continue to lend support to the market, according to Danske Bank A/S.

“I wouldn’t sell Italian bonds on a risk-off event, simply because the ECB is there,” said Piet Christiansen, chief strategist at the bank. “That commitment with its yield curve cap and flexibility embedded in the PEPP shouldn’t be underestimated.”

©2020 Bloomberg L.P.