Italian bonds have had an up and down week as talks continue to potentially form a populist government coalition.
Ten-year Italian bonds recovered a bit on Wednesday, with yields falling to 2.9%, but they are still up 8.6% since Monday's close. Likewise, two-year Italian bond yields fell to 1.7% from 2.87% on Tuesday's close, but are up 88% from Monday's close. Meanwhile, 10-year U.S. Treasuries were yielding around 2.85% on Wednesday, down about 2.7% from Monday's close, as investors sought safe-haven assets.
U.S. Treasuries benefited as Italian parties the Five Star Movement and the League revived negotiations to form a coalition government on Monday. Italy hasn't formed a government since elections in March.
"Given the magnitude of the jump in Italian government bond yields over the last few days, we can really speak about a crisis. The markets are reacting normally for a crisis, with safe havens including German bunds, U.S. Treasuries, dollar, Swiss franc and yen flying higher, while equities and credit are under pressure, especially if related more or less directly to Italy and Europe," said Fabrizio Quirighetti, chief investment officer and co-head of multiasset at SYZ Asset Management, in an emailed comment.
Chris Payne, managing director at GWM Investment Management, agreed. "Italy has the third-highest public debt in the world and so this has really spooked the bond markets," he said. "The spread between Italy's 10 year-bond and its German counterpart is now at its highest since September 2013 and we are now seeing a significant reallocation into safe-haven assets, driving gold prices and the Japanese yen higher."
However, Seema Shah, global investment strategist at Principal Global Investors, said: "Demand at (Wednesday's) auction was very encouraging, and clearly indicates that investors still have faith in the Italian economy, if not the government. Indeed, putting aside the political turmoil, Italy is enjoying a much improved economic and fiscal position. What's more, the extended average maturity of its outstanding bonds and a relatively undemanding issuance schedule for the rest of 2018 suggest that Italy is unlikely to face major refinancing problems in the near term."
Other peripheral bonds such as Portugal and Spain might find the most recent slide down in Italian yields advantageous, according to money managers. Mr. Quirighetti said: "Yesterday morning, we added marginally to Spain five-year government bonds and Portugal 15-year government bonds in our euro-denominated fixed-income funds, where we have very low or little exposure to Italian government bonds, are neutral on Spain and overweight in Portugal."