Will Italy be downgraded to junk?
Italy, home of the third-largest sovereign bond market in the world (after US and Japan) and the third-worst general government balance sheet in the world (after Greece and Barbados), is gambling with arguably its greatest national asset: the privilege of government borrowing at paltry interest rates, virtue of irrevocable membership of the European Monetary System. What may have seemed a mild and entirely justified relaxation of the fiscal stance, in the light of abysmal economic progress, has erupted into a full-on market assault. The reaction to the announcement of a higher than expected budget of 2.4 per cent of GDP (versus 1.6 per cent, anticipated) for the next three years was an immediate re-pricing of 10-year BTPs, currently trading at a yield above 3.5 per cent, its highest since February 2014. With the 5-year CDS at 272bps, credit default protection is now more expensive for Italy than South Africa (230bps) and Brazil (221bps), whose sovereigns are both rated as junk. Investment grade status is hanging by a thread, and with it, membership of elite bond indexes. A very slippery slope awaits.
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