Italian-German yield gap hits lowest level since March 2022
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By Stefano Rebaudo
Feb 19 (Reuters) - Euro zone borrowing costs struggled for direction on Monday, while the gap between Italian and German 10-year yields dropped to its lowest level since March 2022 with investors keen on locking in appealing returns amid expectations for cuts in policy rates.
Italian bonds are well supported, considering more appealing returns than on other euro zone curves, while investors do not see significant threats to the Italian macroeconomic and political environment in the very short term.
"So far, higher-than-average growth has occurred without causing higher-than-average inflation, as supply has been expanding, especially labour supply," said Citi in a note to clients referring to Southern European countries.
"We uncover new strengths that point to sustainably higher growth ahead, even in Italy," it added.
The spread between Italian and German 10-year government bond yields -- a gauge of risk-premium investors ask to hold bonds of highly indebted countries -- was at 146.30 after hitting 145.90, its lowest level since March 2022.
Deutsche Bank strategists argued risk appetite is the main driver behind the recent spread tightening, and Southern Europe's yield gaps are not rich compared to other risky assets.
The Italian German spread tightened in January, although money markets were cutting their bets on rate cuts.
Analysts flagged that the BTP-Bund correlation has increased in the past three months, signalling a smaller impact from Italy-specific factors.
Correlation is a statistical measure that expresses the extent to which two variables – in this case, BTP and Bund yields -- change together at a constant rate.
Prices of bonds from highly indebted countries have benefited from expectations for monetary easing and a very gradual wind-down of the Pandemic Emergency Purchase Programme (PEPP) reinvestments announced in December.
The euro area benchmark Bund yield was flat at 2.40%, still within striking distance of its 2-1/2-month high at 2.422% hit on Friday as markets scaled back bets on future rate hikes.
Traders forecast a quiet session as U.S. markets are closed for Presidents' Day, and no data releases are due.
They will focus on negotiated wage data and policy meeting accounts from the ECB and PMI data later this week.
"We expect them (ECB policy meeting accounts) to reiterate that the rate cut discussion was premature but that data, particularly wage developments, will decide the timing" said Michel Martinez, chief euro economist at Societe Generale.
"Based on the ECB’s wage tracker, which predicts resilient wage growth this year, upside risks to services inflation cannot be ruled out," he added, arguing he sees a first rate cut only after the summer.
Money markets reduced their expectations for the European Central Bank's monetary easing after strong economic data and rate-setters on both sides of the Atlantic warned that central banks must be cautious in easing monetary policy.
They last discounted 105 bps of ECB rate cuts in 2024 from 120 bps on Feb. 13 before U.S. inflation data and from 150 bps early this month.
Analysts said pricing out of cuts may have gone far enough, but at the same time there is no real catalyst to drive the narrative in the other direction.
U.S. Treasuries plunged on Friday, dragging euro area bonds after economic data ratcheted down market expectations for the timing of a rate cut from the Federal Reserve this year. Bond prices move inversely with yields. (Reporting by Stefano Rebaudo, editing by Ed Osmond) ;))
