Bonds and Budgets: Italy vs. EU

Mid Week Bond Update

Bonds and Budgets: Italy vs. EU

The EU sent back Italy's budget for revisions; U.S. Treasuries got a safe-haven boost; macro events showed up in key currencies.

EU to Italy: Let's try that again

The unprecedented formal rejection of Italy’s budget by the European Commission (EC) ended the brief bonhomie between Brussels and Italy’s coalition government, calling the plan’s variance from the European Union’s guidelines “particularly serious non-compliance.” EU procedures give Italy three weeks to submit a revised budget; continued non-compliance could result in financial sanctions by 2019.

The timing of the conflict is especially problematic; as previously planned, the European Central Bank has cut its accommodative bond-buying program in half this month, planning to phase it out completely over the next year.

The wind-down could be making things more challenging for Italy in Europe’s bond market; the possibility of a flight to German Bunds at the expense of Italy’s debt could be what’s driving the Italy-Germany spread, pushing it in the direction of the much-discussed level of 400 basis points (bps)  – despite Prime Minister Conte’s assertion that part of that 400 bps bogey is the assumption of an Italian departure from the euro – which all parties of the Italian governing coalition take great pains to state is completely unthinkable.

Italy-Germany Yield Spread (10-Year)

Source: Bloomberg, October 23, 2018. Correct date? Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


On the Rise: U.S. Treasuries

On October 23, the safe-haven trade seemed to be toward Treasuries, resulting in falling yields across the curve. Of particular interest were the changes at the shorter end of curve (yields at maturities between 2 and 10 years), where yields rose between 3 and 4 bps. This was despite the strong supply coming into the market from the issuance of some $276 billion of bills, notes and floating-rate securities. That’s below the all-time record, which was the $294 billion raised at the end of March of this year.  Observers noted that the result has been to steepen the U.S. yield curve slightly this week, even as momentary worries about the strength of corporate earnings gripped equity markets in the U.S. during the week.

On the Slide: Macro-driven currencies         

With global macroeconomic and geostrategic matters grabbing headlines, it’s little surprise that some key currencies have taken the brunt – at least over the past week. The British pound, the euro and the Australian dollar fell -1.47%, -0.89% and -0.73% respectively, attributable to Brexit, Italy and worries about China’s economy, which has a major influence on Australia’s resource-driven economy.

Two currencies were notable for their stability; the Japanese yen fell a mere -0.16%, as the yen began to attract attention for some of its safe-haven characteristics.  And the Brazilian real rose 0.76% over the past five days, continuing its dramatic upward move since mid-September, as election certainty, combined with embargo-related demand for the country’s exports, gave some relief to the beleaguered economy.


All data Source: Bloomberg, October 23, 2018, unless otherwise indicated.


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