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Credit Insights

U.S. Markets Yawn in Response to Italian Sovereign Debt Market Turmoil

Prices for Italian sovereign bonds dropped precipitously across the board.

Asset markets in the United States yawned in reaction to turmoil in the European asset markets last Friday, as U.S. corporate bond credit spreads and equity prices were relatively unchanged. Prices for Italian sovereign bonds dropped precipitously across the board following Italy's announcement that its budgeted deficit for 2019 would breach the European Union's limit. Currently, Italy's debt/GDP ratio is the second highest in the EU, surpassed only by long-beleaguered Greece. As bond prices fell, the yield on Italy's 2-year bonds rose 25 basis points to 1.01%. In the longer end of the curve, the yield on Italian 10-year bonds rose 26 basis points to 3.14%. By comparison, Germany's 2-year bond still trades at a negative yield of 0.52%, and German 10-years trade at 0.47%. As an indication of the market's perception of Italian default risk, the current spread between Italian and German debt has widened to 267 basis points. The current rates for Italian sovereign debt rival the highest interest rates the bonds have traded at since mid-2014, when the bonds were recovering from the Italian banking crisis. Contagion from this dramatic freefall in the sovereign bond market spread to the equity prices of Italian banks, which fell on average 5.3% and in turn led to a 3.7% decline in the FTSE MIB Index. Germany's DAX dropped 1.52%, France's CAC declined 0.85%, and Spain's IBEX fell 1.45%.

The average spread of the Morningstar Corporate Bond Index (our proxy for the investment-grade market) was unchanged last week at +110. In the high-yield market, the BofA Merrill Lynch High Yield Master Index tightened 1 basis point to +324. While investment-grade bonds still have a ways to go before getting back to the tight levels registered earlier this year, spreads in the high-yield market remain at their narrowest levels of the year, which is also the tightest that they have traded since before the 2008-09 global financial crisis.

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