Italy's Crunch Moment in the Bond Market

(Bloomberg Opinion) -- Italy’s auction of five and 10-year government bonds on Thursday will be the most important test of investor appetite since the country’s political crisis subsided. Buyers are understandably skittish.

Italy's Crunch Moment in the Bond Market

Appetite for the 10-year securities the government sold at the end of May was poor, something I remarked on at the time. Since then, yields on Italy’s two-year bonds have climbed back above one percent, and the premium investors demand to hold 10-year Italian bonds over their German counterparts has increased to 250 basis points, about twice its average this year.

Italy's Crunch Moment in the Bond Market

In recent weeks, yields have jumped after two euroskeptic professors were named to important parliamentary committee posts and Matteo Salvini’s League polled strongly in the weekend’s municipal elections.

Such volatility in Europe’s largest bond market is unsettling for investors — and contrasts starkly with France and Spain.

France is preparing to tap an existing green bond due in 2039, a sign it is after several billion euros. Spain is preparing to sell as much as 9 billion euros ($10.5 billion) of debt maturing in a decade — a sign of how demand has rebounded following the collapse of Mariano Rajoy’s Popular Party government.

To get a sense of how deep demand for Italian debt really is, you need to look at three things: the amount of bids submitted compared with the amount of bonds sold, the sum raised versus the maximum the government initially seeks, and the difference between the price the securities are sold for in the auction compared with the market price when investors submit their bids.

Italy's Crunch Moment in the Bond Market

Italy’s most recent 10-year sale did not go as well as its bid-to-cover ratio suggested. After trying to sell 4 billion euros of bonds, the government was only able to find buyers for 3.6 billion euros — after accepting a discount. This time, Italy is only after 2.5 billion euros. It will need to draw bidders in number. If this sale isn’t a roaring success, brace yourself for a summer of discontent in Italy’s bond market.

©2018 Bloomberg L.P.