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ûYEARSBONDS SSARMarkets take Italy rating cut in its stride
but clouds gather
SSAR Markets monitoring dialogue with European CommissionThe Moody’s downgrade of ITALY has removed
some uncertainty from the market, but although
the near-term outlook is rosier, dark clouds could
gather for 2019 if the country does not change
course on its budget plans.
Moody’s one-notch cut to Baa3 on October 19
was widely expected, and the outlook change to
stable was seen as the most positive outcome for
the sovereign.
S&P, which currently rates Italy at BBB stable,
was scheduled to opine after the market close
on Friday, though that was expected to be a
non-event.
“I think prospects are less bleak than they
were,” a DCM banker said.
“It’s in everybody’s self-interest that this
situation sorts itself out. It’s clear that it’s not
in Europe’s interest to enter into an existential
debate with Italy. We’ll wait and see what S&P
says but I think we’re going to get through
this crisis. It was such a big consensus trade
to be short Italy, it feels like we’re not going to
deteriorate substantially from here.”
Ten-year BTPs were yielding 3.49% last Friday
afternoon, 10bp lower than the previous week’s
close, while the spread to Germany had hovered
in the 300bp-320bp range for most of the week.
It helps that the country is not under huge
pressure when it comes to funding.“The last two months of the year are
relatively easy in terms of net supply,” said
Chiara Cremonesi, a fixed income strategist at
UniCredit.
“Italy has around €25bn in medium to long-
term issuance for November and December.
Redemptions in both months are going to amount
to €42bn, excluding the ECB QE. At the end of the
day, Italy is a country that needs to roll over a lot of
debt so it needs to play the confidence game.”DARK CLOUDS AHEAD
The respite, however, may be temporary.
Markets are closely watching how the dialogue
with the European Commission progresses, and
implementation of the budget in 2019 could
easily ratchet up the pressure.
“Next year investors will be looking at budget
execution, and depending on the size of the
budgetary slippage we will have, they might ask
for bigger premiums on BTPs,” said Cyril Regnat,
fixed income strategist at Natixis.
“Of course, this would be a scenario in which
ratings agencies would start complaining about
this wider budget,” he said.
“This would definitely open the door to
renewed tensions on BTPs and would justify a
widening of the 10-year spread versus Bunds
towards 400bp and more.”If Italy’s deficit reaches the 3% threshold, the
sovereign risks being put under an Excessive
Deficit Procedure.
An EDP - imposed by the Commission
against states that breach the budgetary deficit
ceiling in the stability and growth pact - would
require Italy to provide a plan for corrective
action.
“Markets are sensitive to the risk of an
escalation of rhetoric of Italy versus Europe in
case an EDP is opened,” said Fabio Fois, senior
European economist at Barclays.
UniCredit’s Cremonesi agreed.
“The EDP is an extremely long process. ... It is
all about the tone of the discussion between the
EU and Italy, this is what the market will focus
on,” she said.
At last Thursday’s ECB meeting, President
Draghi said he remained confident that
Italy would reach an agreement with the
Commission.
“For the ECB, the level of contagion is not
big enough to justify any change in monetary
policy,” said Natixis’s Regnat.
“It is an Italian issue, with some spillover
effect on Italian assets, stocks and banks, but
not big enough to trigger something from the
ECB.”
Priscila Azevedo Rocha