Contagion Creeps Back Into Europe's Bond Markets -- 2nd Update
October 19 2018 - 1:37PM
Dow Jones News
By Christopher Whittall and Marcus Walker
Concerns over Italy's finances spread to other European bond
markets this week, in a worrying sign for investors who until
recently hoped that market jitters would be contained.
The gap in yield between 10-year Spanish bonds and haven German
debt hit its widest level since April 2017 during Friday's session
before narrowing later in the day, according to Refinitv, while
Portuguese debt also came under pressure.
The selloff eased in European afternoon trading Friday -- with
Italian and other bonds rallying after 10-year Italian yields hit
their highest level since early 2014 earlier in the day. That
turnaround came after a senior EU official played down tensions
with Italy's antiestablishment government.
But investors predicted the standoff between Brussels and Rome
will continue, likely keeping markets volatile.
Italian bond yields have risen sharply since late September when
the country's government set a 2.4% budget deficit target that put
it at odds with the European Commission. But investors hadn't sold
the debt of other weaker Southern European economies. That kind of
market contagion has rarely been seen since the depths of the
eurozone sovereign-debt crisis over six years ago.
That changed this week, as the extra yield premium investors
demand to hold Spanish debt over similar German bonds climbed to
1.33 percentage point, according to Refinitiv, compared with around
1 percentage point in late September.
"People are very focused on [the] downside risk to Italy and it
has spilled over more in the last couple of sessions," said Ryan
Myerberg, a portfolio manager at Janus Henderson Investors.
Mr. Myerberg said Spain and Portugal's finances look solid. But
in the short-term, something of a "perfect storm" could cause their
bonds to slide, including concerns over credit-rating firms
downgrading Italy and crowded positioning in Spanish debt.
"They won't be immune if Italy continues to move higher in
yields," he said.
Italy is the eurozone's third largest economy and has a public
debt load that equates to around 130% of gross domestic product.
Analysts fear that if Italy crashed out of the common currency,
other weaker economies would be dragged to the exit with it.
The EU's executive arm warned Italy's government in a letter on
Thursday that its budget plans appear to violate commitments to
reduce its debt and deficit. The fact that Rome has opted to expand
its deficit instead of cutting it, and the scale of the deviation
from previous promises, "are unprecedented in the history of the
Stability and Growth Pact," the Brussels-based European Commission
wrote, referring to the EU's fiscal rules.
The government has said it won't change its plans to boost
welfare and pension spending and cut taxes, even if the commission
launches disciplinary proceedings, which could potentially lead to
financial penalties for Italy.
The continuing selloff in Italian bonds challenges government
officials' claim that financial markets are more relaxed about
their economic policies than Brussels. The bond selloff is also
hurting Italy's banking sector, which is heavily exposed to the
government's debt.
But despite bouts of anti-euro rhetoric from Rome's
antiestablishment government, most analysts still see a eurozone
breakup as very unlikely.
"The recent [bond market] move is not a European break up driven
move," said Mr. Myerberg.
Many investors still expect Rome and Italy to reach an agreement
on the Italian budget. That may take some time, though, meaning
bond markets are likely to stay volatile.
"We're looking for a resolution," though it may not come until
December, said Adrian Helfert, senior portfolio manager at
Amundi.
"There'll be an entry point" to buy Italian debt, he said.
Write to Christopher Whittall at christopher.whittall@wsj.com
and Marcus Walker at marcus.walker@wsj.com
(END) Dow Jones Newswires
October 19, 2018 13:22 ET (17:22 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.