LONDON (Reuters) - Italian government bond yields approached unsustainable levels on Tuesday before a parliamentary vote on public finances that could bring down the government of the euro zone’s third biggest economy.
Prime Minister Silvio Berlusconi has denied he is about to step down, as he plans to face down rebels from within his party before the vote. The center-left opposition has said it is preparing a motion of no-confidence that would bring the government even if Berlusconi survived Tuesday’s vote.
Shifts in the Italian yield curve and a widening gap between the prices bondholders demand for Italian debt and what potential buyers are prepared to pay are flashing warning signs similar to those seen in Portugal, Greece and Ireland before high borrowing costs froze them out of debt markets.
The Italian 2/10-year bond yield curve was at its flattest since the 2008 financial crisis around 55 basis points, while five-year yields were higher than those on 10-year bonds, reflecting investor fears they may not get their money back.
In a normally functioning market, investors demand a higher risk premium for longer dated bonds than for shorter maturities.
And in a sign of dwindling liquidity, the bid/ask spread for the September 2021 BTP was at its widest since early August around 60 bps, a level seen before the European Central Bank began buying Italian and Spanish debt in August in an effort to keep borrowing costs down.
“Now we are really reaching very dangerous levels...We are above yield levels in the 10-year where Portugal and Greece and Ireland issued their last bonds,” said ING strategist Alessandro Giansanti.
“If we move above 7 percent it will become a completely different challenge for Italy to find non-domestic buyers.”
The 10-year Italian bond yield rose as high as 6.74 percent before easing slightly to 6.65 percent while two-year paper last yielded 6.10 percent, little changed on the day. The 10-year BTP yield spread over German benchmarks held at 16-year highs around 481 bps.
While strategists and traders said Berlusconi’s departure could trigger a relief rally in Italian debt, this was likely to be temporary until a new government took power which could persuade markets of its commitment to fiscal reforms.
“As long as the market remains unconvinced of Italian authorities’ determination, then BTPs will continue their course north,” Lloyds strategists said in a note.
“Not far from the current Italian/German 10-year yield spreads, we expect clearing houses to start demanding additional collateral for BTPs - similar to the situation seen in Greek, Irish and Portuguese debt.”
Italy has supplanted Greece as the market’s major concern as, with debt equivalent to 120 percent of output, it is considered too big to be bailed out, as Greece, Portugal and Ireland were, with currently available resources.
Greece is still struggling to nominate a leader for a new coalition government forged at the weekend under pressure from the European Union to help it secure its latest bailout package.
German Bund futures reversed earlier gains as the market absorbed a sale of Dutch debt and as stocks rose on earnings and a number of corporate updates.
“We’re seeing some very good buying of the semi-core (European debt) and risk seems to be better bid this morning,” a trader said.
Bund futures were last 13 ticks down on the day at 137.78 with cash 10-year Bund yields up 3 bps at 1.82 percent.
Graphic by Scott Barber, editing by Nigel Stephenson