What if Italy were downgraded to junk?

Much as for other EU Member States, Italy’s public debt ratio is set to deteriorate, as it is expected to jump to 160.7% in 2020. Under these conditions, one can expect credit rating agencies to turn the screws on Italy in coming quarters. Were Italy’s rating to be downgraded to junk, this would probably revive dissensions within the ECB. Italy would be forced to seek support from both the ESM and the ECB in the form of o utright monetary transactions as well as a waiver of minimum credit rating requirements. Even assuming this support is forthcoming, spreads against Bund would widen right across the curve, with the BTP -Bund spread likely to end up stabilising around 275bp in the case of the 10-year (and around 200bp at the short end of the curve). The credit market has significant exposure to the Italian risk, as Italian issuers have a between 10% and 20% weight in iBoxx € indices in the case of Financial Subs and High Yield notably. Under the stress scenario for BTP triggered by Italy’s sovereign rating downgrade to Speculative Grade, our recommendation would be to underweight Insurance Subs and High Yield (cash and iTraxx X-Over ) in favour of Corporate Hybrids and, to a lesser extent, Corporate Seniors. The sensitivity of Italian corporates to BTP has been decreasing since 2012, in particular for Enel on account of its greater geographical diversification. While t he ratings of Snam and Terna would be likely to move in sync with Italy’s sovereign rating, it should not be the case of the Enel and Telecom Italia ratings .