By Christopher Whittall, Alistair MacDonald and Marcus Walker
Italy's credit was cut by Moody's Investors Service Friday to
the lowest investment-grade rating, in a move that will likely add
further selling pressure on Italian bonds and raise borrowing costs
for the debt-laden country.
Italy's bonds had already sold off again on Friday before
recovering later in the day. This past week, selling also spread to
other Southern European economies, in a worrying sign for investors
who until recently hoped that market jitters would be
contained.
Moody's downgraded the country's credit rating to Baa3 from
Baa2, citing a "material weakening in Italy's fiscal strength"
after the government targeted higher budget deficits and stalled
economic and fiscal reforms.
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.
"Italy's public debt trend is vulnerable to weaker economic
growth prospects, which would see the public debt ratio rise
further from its already elevated level," Moody's said in an
emailed statement.
While many investors had anticipated a credit downgrade, the
move to one notch above a junk rating is still a significant
threshold, given some funds can't hold sub-investment-grade
bonds.
Further selling could add to pressure on the eurozone's
markets.
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 Refinitiv, while
Portuguese debt also came under pressure.
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 past week, as the extra yield premium
investors demand to hold Spanish debt over similar German bonds
climbed to 1.33 percentage points, according to Refinitiv, versus
about one percentage point in late September.
Still, the selloff eased in European afternoon trading Friday --
with Italian bonds rallying after the country's 10-year yields hit
their highest level since early 2014 earlier in the day. That
turnaround came after a senior European Union official played down
tensions with Italy's antiestablishment government.
But investors predicted the standoff between Brussels and Rome
will continue, likely keeping markets volatile.
"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's 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 about 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 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 Brussels 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,
Alistair MacDonald at alistair.macdonald@wsj.com and Marcus Walker
at marcus.walker@wsj.com
(END) Dow Jones Newswires
October 19, 2018 18:50 ET (22:50 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.