Monday, July 16, 2012

Italy faces bond sale test after Moody's downgrade

MILAN (Reuters) - Italy's auction of up to 5.25 billion euros in bonds on Friday looks altogether more testing after Moody's cut its rating on the euro zone's third-largest economy to just two notches above junk status.


The agency downgraded Italy's sovereign rating by two notches to 'Baa2', citing rising risks of higher funding costs and a loss of market access.

It warned it may cut it further. The unexpected move weighed negatively on Italian bonds in early trade but a new three-year bond on sale on Friday still traded at levels which pointed to a fall in the cost of borrowing from a month ago.

"The (Italian government bond) futures have opened sharply lower, we have a tough day ahead of us," an Italian bond trader said.

"The negative outlook is particularly worrying." Ten-year Italian government bond yields rose 13 basis points to 6.04 percent, while five-year yields were up 15 bps to 5.55 percent in response to the Moody's action.

The Treasury is offering a new July 2015 bond carrying a 4.5 percent coupon and new tranches of three bonds due in 2019, 2022 and 2023 that are no longer issued on a regular basis.

It last sold three-year paper a month ago, right before pivotal elections in Greece and soon after a sketchy accord to support Spanish banks that failed to reassure investors.

It then paid an average 5.3 percent yield, the highest since December, on the three-year maturity. On Friday morning the three-year bond yielded around 4.9 percent, around 10 basis points higher on the day.

Analysts have attributed the fall in yields to progress achieved on Spain's bank bailout but warn volatility on bond markets is very high and sentiment extremely fragile.

Prime Minister Mario Monti this week did not rule out Italy may in the future need to seek support for its bonds from the euro zone's rescue funds. Moody's said that, given the size of the Italian economy, such mechanism could only give limited support.

"The backdrop remains fundamentally challenging," analysts at Citi said in a note.

Domestic demand should still help the Treasury clear the sale, thanks also to the relatively small amounts offered both for the new issue and the other three bonds. These were probably specifically requested by primary dealers.

A decision to cancel a mid-August bond sale - in line with a practice adopted in recent years - should also be supportive.

On Thursday, Italy saw its one-year debt costs drop by more than one percentage point from a month earlier at a bill sale.

POLITICAL RISK

Moody's said Monti had made substantial progress on structural reforms which, if sustained, could improve the country's competitiveness and growth potential.

But with the prime minister saying he will not stand in next year's election, there is significant uncertainty for the markets to price in.

Former premier Silvio Berlusconi, who resigned last year in the middle of financial turmoil that risked tipping Italy into a Greek-style debt crisis, will be the centre-right candidate in next year's election, a senior official in his PDL party was quoted as saying on Thursday.

Saddled with a 1.95 trillion euro debt pile and chronic growth problems, Italy has been hit by the investor concerns over Spain, with the two countries often bracketed together as the most vulnerable to a worsening in the crisis.

Moody's cited an increased likelihood that Spain may require further external help in its statement.

Euro zone finance ministers this week made 30 billion euros available by the end of July for troubled Spanish banks.

Madrid unveiled further austerity measures on Wednesday after being granted more time to meet its fiscal targets."Italy's perceived creditworthiness is externally driven," said Nicholas Spiro at Spiro Sovereign Strategy.

"We find it extremely worrying that there is still insufficient differentiation between Spain and Italy in the markets."

Italy has greater funding needs compared to Spain but it can rely on a bigger and more diversified domestic investor base.

With euro break-up worries keeping foreign investors away from Italian bonds, domestic support is key for the Treasury, which has roughly another 180 billion euros in debt to raise before the end of 2012.

yahoo.com

No comments: