Italy’s Bonds Drop After Fitch Downgrade; German Bunds Advance

Italy’s government bonds fell for a second day after Fitch Ratings downgraded the nation, saying inconclusive elections threatened its ability to respond to recession.

Two-year notes led losses as Fitch said after markets closed last week that Italy’s recession was “one of the deepest” in Europe. German 10-year bunds rose for the first time in six days as investors sought the region’s safest assets. Spain’s 10-year yield declined to the lowest level since November 2010 after Economy Minister Luis de Guindos predicted economic growth would resume before year-end.

“The move looks to be related to the move by Fitch,” said Luca Cazzulani, a senior fixed-income strategist at UniCredit Global Research in Milan. “We should be prepared for a very long period of uncertainty and volatility on the Italian yield curve. It is difficult to see the market taking a clear direction.”

Italy’s 10-year yield climbed three basis points, or 0.03 percentage point, to 4.63 percent at 4:45 p.m. London time. The 5.5 percent bond due in November 2022 fell 0.26, or 2.60 euros per 1,000-euro ($1,301) face amount, to 107.095.

The two-year yield increased five basis points to 1.80 percent after rising as much as 12 basis points, the most since Feb. 26.

Fitch lowered Italy’s sovereign rating to BBB+ from A- with a negative outlook, according to a statement released March 8. That’s three levels above junk and one higher than Spain, according to data compiled by Bloomberg.

‘Political Uncertainty’

“The increased political uncertainty and non-conducive backdrop for further structural reform measures constitute a further adverse shock to the real economy,” Fitch said.

Italy’s bonds have trailed behind their Spanish counterparts since the parliamentary elections on Feb. 24-25 failed to produce a clear winner, threatening outgoing Prime Minister Mario Monti’s austerity program.

The extra yield investors get for holding Spanish 10-year bonds instead of their Italian counterparts narrowed five basis points today to 11 basis points. The spread has contracted from 116 basis points in July, according to data compiled by Bloomberg based on closing prices.

Further Downgrades

“Investors are starting to realize that further rating downgrades can follow” in Italy, said Alessandro Giansanti, a senior fixed-income strategist at ING Groep NV in Amsterdam. “The latest political news points to a deadlock in the discussions to form a new government. Spain has a majority government and it has regained investors’ confidence after the reduced budget deficit in 2012.”

Yields on sovereign securities moved in the opposite direction from what ratings suggested in 53 percent of 32 upgrades, downgrades and changes in credit outlook last year, according to data compiled by Bloomberg published in December.

De Guindos said the extra yield investors demand to hold Spain’s 10-year bonds instead of similar-maturity German bunds should shrink below 300 basis points, without giving a time frame. The spread was little changed today at 324 basis points.

“All the problems we had are being brought under control and at the end of this year we’ll start to grow,” De Guindos said in an interview with Antena 3 television station posted on the Internet. “If we don’t have setbacks with the euro, we could see positive surprises.”

Spain’s 10-year bond yield was little changed at 4.76 percent after falling to 4.72 percent, the lowest level since Nov. 22, 2010.

Spain is scheduled to auction as much as 5.5 billion euros of 189- and 371-day securities tomorrow, while Italy is due to sell 7.75 billion euros of 12-month bills.

Bunds Gain

German bunds advanced even as a government report showed exports rose more in January than economists predicted, adding to signs that Europe’s largest economy is gathering momentum.

Shipments abroad climbed 1.4 percent from December, when they gained 0.2 percent, the Federal Statistics Office said. Economists forecast an increase of 0.5 percent, according to a Bloomberg News survey.

The German 10-year yield fell one basis point to 1.51 percent after climbing to 1.54 percent on March 8, the highest level since Feb. 25.

Europe’s largest economy is trimming 2013 debt sales to 250 billion euros, down 5 billion euros from 2012. Regulators are also pushing financial institutions to hold more top-rated assets, said Christoph Rieger, head of fixed-income strategy at Commerzbank AG in Frankfurt.

“Demand for quality assets is expected to rise at a time when Germany just achieved a budget surplus and risk sentiment is still shaky,” Rieger said. “The structural changes in the market and scarcity premiums it creates should keep bund yields low for the time being.”

Bond Movers

Volatility on German bonds was the highest in euro-area markets today, followed by those of Finland and the Netherlands, according to measures of 10-year debt, the yield spread between two- and 10-year securities, and credit-default swaps.

Italy’s government bonds returned 0.6 percent this month through March 8, according to indexes compiled by Bloomberg and the European Federation of Financial Analysts Societies. Spanish securities rose 1.6 percent, while Germany’s fell 0.4 percent.

Before it's here, it's on the Bloomberg Terminal.