Italian two-year yield spikes to 2.7% – is this a buy opportunity?

In the meantime, investors have to be ready to endure more volatility from Italian sovereigns. If a technocratic government led by Cottarelli proves impossible, new elections will be called as soon as possible, most probably leading to a populist victory.

If Cottarelli manages to form a new government we can expect volatility to stall during the summer months until the next elections are called.

However we look at the situation, nothing changes the fact that a yield of 2.7% for a G7 sovereign in EUR with two-year maturity is sexy, the only problem is: have we already touched the dip? The spread between two-year BTPs and bunds of the same maturity is 348 bps, the highest since mid-2012 when this spread reached 440 bps.

There is definitely space for more weakness, especially if Moody’s goes through with the downgrade mentioned in the past few days.

Portuguese government bonds are sliding with Italian sovereigns – should we worry?

Not surprisingly, the yield of other peripheral government bonds rose in sympathy with Italian BTPs; after Greece the biggest intraday loser was Portugal with yields moving up by 46bps before closing up 11bps. The sensitivity of  Portuguese sovereigns probably comes down to the liquidity of Portuguese bonds; Portugal only has €221.4bn of bonds outstanding compared to €1.38 trillion for Spain and €2.78 trillion for Italy. This makes Portuguese sovereigns highly sensitive to volatility within the periphery.

The 10-year Portuguese government bond reached a record low yield of 1.60% in April, and now it is back at 2.16% – the same level seen in October of last year. Apart from negative sentiment in the periphery, investors have little to worry about from Portugal. The country has been able to implement reforms that have led it to a decrease in debt-to-GDP and it needs little funding for the rest of 2018. If Portuguese government bonds continue to slide they could became a real opportunity for investors who still want to ride volatility in the periphery but don’t want to be too exposed to its culprit.

High-yield space in second place

Since the beginning of May, spreads of high-yield EUR-denominated debt have been widening to levels previously seen in April 2017. According to the Bloomberg Barclays Pan-European high-yield (euro) average OAS index (LP020OAS), the average option-adjusted spread of high-yield corporates in Europe is 340 bps. Now that the spread between two-year BTPS and bunds is around 353 bps, it is fair to ask ourselves whether it makes sense to be invested in lower-rated, longer-maturity corporate debt.

The OAS spike in this space is obviously mainly led by losses incurred by high-yield Italian corporate names, but if the problems surrounding Italian euro-skeptic sentiment deepen, we can expect high-yield EUR corporates to suffer greatly and incur a stronger repricing.