Italian bond yields head higher as risk appetite takes a hit

Italy's borrowing costs rose on Monday as risk appetite in world financial markets took a hit from signs of a pick up in new cases of the coronavirus.

Stocks across Europe tumbled 1%, which put pressure on lower-rated bond markets in the single currency bloc such as Italy. An easing of lockdown restrictions in some European countries had boosted hopes for a swift economic recovery, but the early optimism soon fizzled as the focus turned to signs of a rise in coronavirus cases.

South Korea warned of a second wave of the virus as infections rebounded to a one-month high, while new infections accelerated in Germany, which has been easing its lockdown. "It's hard to pin-point a catalyst for the move in bonds -- maybe the news from South Korea and Germany has refocused markets' minds that the return to normality will take time," said Richard McGuire, head of rates strategy at Rabobank.

Italian bond yields were higher across the curve, with 10-year yields last up 9 bps on the day at 1.89%. As the selloff in the Italian market gathered pace, yields on safe-haven German bonds fell back. Germany's 10-year Bund yield was just marginally higher on the day at around -0.53% .

Credit rating agency Moody's left Italy's ratings unchanged on Friday, but DBRS Morningstar cut Italy's ratings trend to "negative" from "stable". DBRS blamed considerable uncertainty over the economic repercussions stemming from the COVID-19 outbreak, adding that Italy's rating outlook remained weak.

Mizuho bond strategists said they expected the "fundamental weakness" of the periphery to persist. "The trajectory towards a sub-IG (investment grade) rating for Italy remains inexorable, and it is only a matter of time before funds begin to move to pre-empt rating downgrades," they said in a note.

Italian bonds have also been hurt in the past week by a German constitutional court ruling that cast doubt over the future of the European Central Bank's bond-buying programmes, which have helped to lower Italian borrowing costs. The European Commission could open a legal case against Germany over the court ruling, the EU executive arm said on Sunday.

The EU's top court - which had previously given a green light to the ECB scheme - and the European Commission have said that EU law holds precedence over national regulations. "It is a worry that a court in a big European country is making this ruling but it is also clear that the ECB is not under its jurisdiction as the European Court of Justice has already ruled that the ECB is not overstepping its mandate," said Matthias Weber, an economist at the University of St. Gallen.

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