Another Week, Another Risk That Weighs on Italy’s Battered Bonds

(Bloomberg) -- Investors in Italian bonds seem to find themselves facing a new risk every week.

This time it's a German court ruling that could determine the level of support Italy's debt markets can draw from European Central Bank's quantitative-easing program. Also, there's a May 8 ratings review by Moody's Investors Service that may threaten the Mediterranean nation's ability to finance a recovery from the economic havoc wreaked by the coronavirus.

The yield premium on Italy's 10-year debt over German equivalents jumped 36 basis points in April, the most since October 2018. The spread widened this week even as the ECB unveiled fresh measures to support regional markets.

Now all eyes are on a constitutional court in Karlsruhe, Germany, which will rule Tuesday on whether the ECB can break a key tenet of its bond-buying program to step up support for the region's more vulnerable economies. Italian bond holders will be seeking confirmation that the central bank can deviate from the so-called capital key, which dictates purchases according to the size and population of each country.

A ruling that allows a relaxation of the capital key would let the ECB increase purchases across all euro-area bonds, significantly boosting the rate of buying in Italy and Spain, helping keep yields there at more sustainable levels, according to Huw Worthington, rates analyst at Bloomberg Intelligence.

After this week's surprise sovereign downgrade by Fitch Ratings to just one notch above junk, Italy faces the Moody's Investors Service's review of its Baa3 rating, its lowest investment grade, on Friday. However the ratings agency recently said that the nation's creditworthiness should remain broadly unaffected.

BOE in Focus

For Thursday's scheduled Bank of England policy meeting, money markets aren't pricing in a rate cut. In fact, there is less than one basis point of easing anticipated by year-end. However, there are other measures at the bank's disposal and Citigroup Inc. expects the BOE to increase its bond-buying program by 200 billion pounds ($250 billion), to absorb the unprecedented U.K. debt sales.

“If any doubts over the BOE backstop creep in, the price-sensitive private market would likely require a rapid rise in yields to turn net buyers again,” Jamie Searle, a rates strategist at Citigroup, wrote in a note. “The BOE is unlikely to test that theory, especially with Brexit uncertainty on the near horizon.”

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Euro-area bond sales are set pick up next week with offerings from Germany, France, Spain and Austria totaling around 23 billion euros ($25 billion), according to Citigroup. French offerings are set to comprise half of that, with a record sale target of 11.5 billion euros. There are no redemptions or coupons scheduled to be paid next week.

The U.K. will offer around 11 billion pounds of debt across four sales as it seeks to reach its 45-billion-pound issuance target for the month. The BOE will maintain its bond buying program across nine operations at a pace of 1.5 billion pounds per maturity bucket. U.K markets will be closed on May 8 for a national holiday.

Data for the coming week is sparse and mostly relegated to second-tier, backward-looking figures.
- May's Sentix investor confidence numbers for the euro area are due on Monday, and are forecast to rebound slightly from a record low last month
There are no speeches due from the ECB, which will publish its survey of professional forecasters on Monday; Bank of England governor Andrew Bailey speaks after Thursday's rate decision
Moody's Investors Service reviews Italy and Greece, DBRS reviews Italy and Finland on Friday