Italy’s Bonds Hold Rise as Credit Rating Threatened by Politics

  • DBRS places Italy’s rating under review as referendum looms
  • 10-year yields rise from 17-month low reached last week

Italy’s government bonds held a two-day advance as the nation’s sovereign rating came under review before a proposed constitutional referendum.

Yields on the nation’s 10-year debt increased from a 17-month low reached Friday. Ratings company DBRS Ltd. said on Aug. 5 that it was reevaluating its A (low) credit grade, with negative implications. Italy’s highest court backed the request for the referendum Monday, according to an e-mailed statement.

This paves the way for Prime Minister Matteo Renzi to proceed with the vote, which is aimed at overhauling the political system. Renzi has said he will resign if voters reject the measure, which would be a blow to a country already struggling to deal with a banking crisis.

“DBRS to a large degree has had a benign rating relative to the three other big ratings agencies” for Italy, said Christian Lenk, a fixed-income strategist at DZ Bank AG in Frankfurt. “Some investors may be starting to reflect whether the current, low-spread environment that we have with respect to peripheral bonds is justified, given the risks that still linger.”

Italy’s 10-year bond yields were little changed at 1.13 percent as of 4:10 p.m. London time, having dropped to 1.128 percent Friday, the lowest since March 2015. The price of the 1.6 percent security due in June 2026 was 104.37 percent of face value. Similar-maturity German bund yields rose one basis point, or 0.01 percentage point, to minus 0.057 percent.

That left the yield difference, or spread, between the securities at 1.19 percentage point Monday, the lowest on a closing-price basis since April.

DBRS Rating

While DBRS is smaller than Moody’s Investors Service, S&P Global Ratings and Fitch Ratings, its ranking on Italy’s debt is significant because it’s higher than the other three companies and therefore is the one the European Central Bank uses for grading collateral for its liquidity operations.

A ratings downgrade means banks would be charged more by the ECB for accepting those lower-rated securities as collateral for loans.

If DBRS were to downgrade Italy, “the best rating in the ECB’s eyes would move from credit quality Step 1 to Step 2,” analysts at Rabobank International, led by Richard McGuire, London-based head of rates strategy, wrote in a note to clients. “Therefore, the country’s bonds would attract higher haircuts when used by banks to borrow.”

Bond Returns

Italian government securities earned 4.6 percent this year through Friday, according to Bloomberg World Bond Indexes. That compares with 6.4 percent return from both German and Spanish sovereign debt.

Bonds across the euro area were also weighed down after a higher-than-forecast U.S. jobs report Friday bolstered wagers that the Federal Reserve will tighten monetary policy this year. Futures showed a 48 percent chance of a rate increase by December after the nonfarm payrolls data, up from about 36 percent at the start of August.

DZ Bank’s Lenk said that while traders repriced the timing of Fed tightening, he “would very much doubt we would see an ongoing selloff into the new week. For the time being, a further rise in yields on euro-area govvies should be limited,” he said.

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