Euro zone bond yields edge up, ratings upgrade supports Italy

Most euro zone bond yields nudged up on Monday, although a Fitch ratings upgrade supported Italy's bond market with 10-year yields touching a two-week low. Most other long-dated bond yields in the bloc also nudged higher on the day. Bond strategists expected issuance in the euro area at around 10 billion euros this week, winding down ahead of the year-end.

Most euro zone bond yields nudged up on Monday, although a Fitch ratings upgrade supported Italy's bond market with 10-year yields touching a two-week low. Trading across the single currency bloc was generally subdued as investors awaited more details on the new Omicron coronavirus variant and what it means for the global economic outlook and European Central Bank policy.

Fitch Ratings late on Friday lifted Italy's sovereign credit rating by one notch to BBB, citing confidence in the economic outlook supported by the use of the European Union's post-pandemic recovery fund. That ensured a positive start to the week for Italian bonds, with prices rising and yields falling. Italy's 10-year bond yield fell 2.5 basis points to a two-week low around 0.90%.

And although it pulled back to around 0.92%, Italy still outperformed most of its euro zone peers. "It's completely consistent with the positive fundamental picture that we have on Italy over the medium term, and in fact, it makes us even more confident that we will see further rating upgrades down the line," said Camille de Courcel, head of G10 rates strategy, Europe at BNP Paribas, referring to the Fitch ratings upgrade. Italy's 10-year bond spread over Germany narrowed slightly to 128 basis points from 130 bps late on Friday but remained about 17 bps wider than levels seen a month ago - reflecting increased uncertainty priced into peripheral bond spreads over the ECB policy outlook.

The ECB may set policy for a relatively short period at this month's meeting, given heightened uncertainty, but should not delay a decision as markets need direction, ECB President Christine Lagarde told Reuters on Friday. "We are bracing ourselves for quite a lot of market – and policy communication - volatility as we assess the severity of the Omicron variant, as the market may focus on incomplete data together with alternating encouraging or concerning “soft” messages," AXA Group chief economist Gilles Moec said.

Germany's benchmark 10-year Bund yield was up around one basis point at around -0.37%, rising in line with U.S. Treasury yields as world stock markets staged a tentative rebound. Most other long-dated bond yields in the bloc also nudged higher on the day.

Bond strategists expected issuance in the euro area at around 10 billion euros this week, winding down ahead of the year-end. Many of the bloc's issuers are also expected to unveil their issuance plans for the year ahead.

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