After an initial burst of panic selling in May, Italian bond yields have continued to drift higher - the yield on the Italian 10Y is now well above the May highs - as the coalition government’s fiscal plans and expensive election promises have remained a key focus for investors and Brussels all summer, spooking bondholders who have continued to quietly offload their holdings of Italian bonds amid fears of an angry response from the EU to Italy's "budget busting" ways.
Such fears will only grow after Italy’s populist leaders rejected the finance minister’s attempts to reassure investors that Italy won't engage in a spending spree, and insisted voters’ needs must come before European spending constraints. Speaking at an event in Italy on Sunday, deputy Prime Minister Matteo Salvini said that next year’s budget will see the deficit almost double to "touch" the EU's 3% deficit ceiling.
Quoted by Bloomberg, he said that the government will "try to respect all the hurdles Europe imposes, but the well-being of Italian citizens comes first," he said.
Reminding markets that Italy remains Europe's bond market flashpoint, on Friday Fitch Ratings cited budget concerns as it changed its outlook on Italy to negative from stable, even as it kept the overall rating unchanged, just two notches above junk.
In response to the Fitch announcement, Italian bonds initially rose on Monday with the 10Y yield 3 bps lower at 3.19 percent on relief that Fitch’s verdict wasn’t more severe. However, the early gains were quickly erased and the yield on 10Ys quickly rose back to multi-year highs, as the market continues to fret over the government's budget plans and the growing sense of discord within the government.
To that point, in an interview with La Repubblica, finance minister Giovanni Tria said he is fighting to contain public spending and said that bonds will rise further when investors see the details of the 2019 budget. “Budget stability will be respected,” he said, although he probably did not expect Salvini to dash optimistic outlook within hours.
Tria, an economics professor drafted at a late stage of the coalition negotiations, has been trying to rein in the ambitions of Salvini and Luigi Di Maio of the anti-establishment Five Star Movement, though as Bloomberg notes, "he lacks the political muscle of the two populist party leaders." The Italian government is due to set new public-finance and economic-growth targets by Sept. 27 and submit a draft budget to the European Commission by Oct. 15.
Salvini’s view of the 2019 deficit - a product of his generous campaign promises - is in stark contrast with the targets set by Italy’s previous government. They saw the budget gap narrowing to 0.8 percent of GDP from 1.6 percent this year. Tria told Bloomberg News in July that his aim is not to worsen the structural-budget situation and possibly to improve it. Still, he’s also said that slower-than-expected...