Italian government bonds are coming under increasing pressure despite the European Central Bank’s huge asset-purchase programme, as investors worry about the enormous debt load Italy and other eurozone members are taking on to combat the coronavirus crisis.
A sell-off in Italy’s government debt extended to a second day on Wednesday, pushing the country’s 10-year yield to a four-week high of more than 1.8 per cent. Bonds issued by Greece, Portugal and Spain also weakened.
The gap between Italian and German yields — a measure of risk in eurozone bond markets — widened to more than 2.2 percentage points, reversing more than half of the narrowing seen since the announcement of the ECB’s €750bn Pandemic Emergency Purchase Programme on March 18.
The shake-up underlines that without a way to pool risk across all euro members, investors will be forced to focus on the financial risk each country is taking on to fight the pandemic.
“What matters to markets is the sense that we are not seeing solidarity at a time of crisis. Instead, it’s every man for himself,” said Mark Dowding, chief investment officer at BlueBay Asset Management. “That is going to fuel Euroscepticism, which eventually sees fears of a break-up getting priced in. As an investor, I think that dynamic is more important than the finer points of any eurozone deal.”
Fears over debt sustainability have intensified since eurozone finance ministers last week failed to include jointly issued so-called “corona bonds” in their crisis-fighting package. An Italian push for shared debt was squashed by Germany and the Netherlands, which prefer to see relief efforts channelled through the eurozone’s bailout fund.
Italy’s debt burden will rise to more than 150 per cent of gross domestic product this year, up from 134 per cent last year, Rabobank is projecting. Debt will climb to 108 per cent of output in Spain and 128 per cent in Portugal, while Germany will see a much more modest rise to 63 per cent, according to the bank.
Some fund managers are reluctant to buy into Italy’s relatively high-yielding debt despite the backing of the ECB, fearing a political backlash to the crisis that could reawaken questions about eurozone membership and weaken the bonds further.
“[The] creditworthiness of member states is back at the centre of the market’s radar,” said Richard McGuire, a rates strategist at Rabobank. “It’s not just an Italy issue, it’s right across southern Europe. We are moving back to a two-speed continent,” he said.
Yields in Italy are still well short of the peak of almost 3 per cent hit a month ago and far below the heights reached during the eurozone debt crisis. Heavy buying by the ECB has ensured all eurozone members can borrow from bond markets. Greece, considered the bloc’s riskiest issuer, gathered robust demand for new seven-year debt on Wednesday. Athens received more than €5bn of orders for the bond, its first since junk-rated Greek debt was included in the ECB’s purchase programme.
The central bank bought more than €20bn of bonds under the PEPP last week, on top of €30bn the week before. The ECB may need to step up the pace of purchases in order to keep a lid on yields, according to ING rates strategist Antoine Bouvet.
“Benign borrowing conditions for the emerging debt tsunami will have to be ensured,” he said.