Italian bonds in heavy selloff on ECB policy tightening fears

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Italian government bond yields jumped on Monday after the European Central Bank last week opened the door to speculation about a monetary tightening in March.

Peripheral bond prices were underperforming their peers as a faster-than-expected monetary tightening would hurt more bonds of most indebted countries.

“Investors’ focus is shifting to net supply which will be higher in 2022 after the ECB’s hawkish shift, and will need to be absorbed by the private sector,” said Fabio Castaldi, senior investment manager at Pictet Asset Management.

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“Such a scenario will increase risk premium mostly for highly indebted countries.”

Italy’s 10-year government bond yield rose 11.5 bps to 1.831%, touching a fresh high since May 2020.

Yields on shorter maturities jumped by around 13 bps, with the 5-year rising above 1% for the first time since June 2020.

The closely watched spread between German and Italian 10-year yield rose to 161 bps, its widest since August 2020.

Spanish and Portuguese 10-year borrowing costs rose around 8 bps.

Five-year credit default swaps (CDS) for Southern European countries – a measure of insuring exposure to their debt – rose with Italian CDS gaining 4 basis points (bps) from Friday’s close to 100 bps, levels last seen in January 2021.

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Money markets are currently pricing an 80% chance of a rate hike in June and a rate hike of more than 50 basis points by December 2022.

Germany’s 10-year government bond yield, the benchmark of the euro zone, rose 2.5 basis point to 0.23%, its highest level since January 2019.

The 5-year yield was in positive territory at 0.032%, up 3 bps. The 2-year yield hit a fresh high since September 2015 at -0.21%.

Some investors expect that ECB President Christine Lagarde might try to appease rate hike jitters at her testimony before the European Parliament at 1545 GMT.

“Following the hawkish turn in the press conference on Feb. 3, the focus will be on whether there is any dovish pushback,” Citi analysts said in a note, mentioning Lagarde and a speech of the ECB chief economist Philip Lane due on Thursday.

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The ECB could end its stimulus program earlier than planned, but it is unlikely to raise its primary interest rate in July as investors are expecting, ECB policymaker Martins Kazaks told Reuters.

“I expect the ECB to reiterate its statements and successively prepare the market for a first-rate hike in Q4 2022 or Q1 2023,” Berenberg analysts said in a note to clients.

Lagarde might “reassure that the exit process will follow the sequence and will in all likelihood be gradual, which could argue for some near-term stabilization,” Commerzbank analysts said in a note.

(Reporting by Stefano Rebaudo, additional reporting by Karin Strohecker and Sujata Rao; editing by Mark Heinrich)