Italy’s government bonds underperformed their euro zone peers on Tuesday as markets remained focused on the path of U.S. monetary policy normalisation and surging inflation. Bets that the Federal Reserve may lift interest rates as early as March have ignited a major sell-off on bond markets in the last few weeks. Those remained in focus on Tuesday with Fed Chair Jerome Powell in comments prepared for delivery at a congressional hearing later in the day pledging “to prevent higher inflation from becoming entrenched”. Some of Wall Street’s biggest banks now expect four U.S. interest increases this year starting in March, a more aggressive call than a week ago.
The 10-year bond yield in Italy, which rolled over into a new benchmark, was up at 1.37 percent after briefly reaching 1.388 percent, its highest level since June 2020. While a new underlying contract magnified the change in benchmark BTP yields, investors were concerned about the country’s political stability if Prime Minister Mario Draghi resigned and assumed the presidency as parliament reconvenes this month to elect a new leader.
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Bond yields kept near their recent highs on Tuesday and Germany’s 10-year yield was unchanged at -0.041% after rising to -0.025% on Monday, the highest since May 2019, and near positive territory. Italy’s 10-year bond yield, which rolled over into a new benchmark, was up at 1.37% after briefly touching its highest level since June 2020 at 1.388%.. While a new underlying contract made the move in benchmark BTP yields appear large, investors were also worried about the country’s political stability should prime minister Mario Draghi leave his job and assume the presidency as parliament convenes this month to choose a new head of state. The Italian-German 10-year yield spread widened to 140 bps.
“According to foreign investors, Draghi leaving his role as a prime minister to become head of state represents a major threat. If that happens we will probably see the BTP/Bund spread over the 160 basis points level,” said Saxo Bank strategist Althea Spinozzi. “In the first quarter of 2022, as long as there will be political uncertainty, we will have spreads volatility,” she added. Uncertainty over the Italian Presidential election as well as its implications for government stability and the reform agenda is rising, according to Carlo Capuano, Vice President, Global Sovereign Ratings at DBRS Morningstar. The European Central Bank President Christine Lagarde reassured euro zone citizens worried about rising prices saying they can trust the ECB to stabilise inflation, which rose to a record 5% in December. And ECB chief economist Philip Lane said the ECB does not see euro zone inflation above its 2% target in the medium term. In the primary market, Spain raised 10 billion euros ($11.33 billion)from the sale of a new 10-year bond via syndication with demand over 63 billion euros. And Portugal mandated a syndicate of banks for the sale of a 20-year bond, according to a memo seen by Reuters. ($1 = 0.8826 euros)
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