The prospect of a spendthrift government taking shape in Italy, the euro zone’s third-biggest economy and its most indebted after Greece, has rattled markets.
Italian two-year bond yields jumped more than 10 basis points to 0.23 percent, their highest since December 2016, before pulling back in afternoon trade to 0.17 percent. A week ago, that yield was at minus 0.11 percent.
The gap between 10-year Italian and Spanish bond yields was at 81 basis points — the widest since 2012, when the euro area was starting to emerge from a debt crisis.
As 10-year Italian debt yields hit 10-month highs at almost 2.30 percent, the gap over benchmark German Bund yields pushed out to 175 bps — the widest since October. [Note: it's now 2.41%]
“If this is the government we’re going to get, the Italian/German bond spread north of 180 bps is certainly a possibility,” said Patrick O’Donnell, investment manager at Aberdeen Asset Management in London.
Complacency Still Abounds
The jump in yields is significant, yet it still smacks of major complacency. The yield on the 10-year US note is 3.07%.
There is a clear risk of Italy leaving the Eurozone, and that is not remotely priced in.
Everyone assumes that because Greece did not leave, Italy won't either. Regardless of what one believes, the odds of Italeave are certainly not zero. A yield of 2.41% does not begin to reflect the risk.
Mike "Mish" Shedlock