UPDATE 3-Italian bond yields jump, German curve negative as coronavirus hits Italy

Italy's borrowing costs jumped on Monday and the German bond yield curve was back in negative territory after the China coronavirus outbreak spread to Italy, increasing concern over the outlook for the eurozone economy. A fourth person infected with the coronavirus has died in Italy, officials said on Monday as the government struggled to contain the outbreak.

In addition to Italy, a sharp rise in infections in South Korea and Iran has fuelled fears that the coronavirus outbreak will become a pandemic with disruptive and deadly consequences around the world. "The issues in Italy have not gone away," said Justin Onuekwusi, a portfolio manager at Legal & General Investment Management. "This is another external shock, which will leave them in a very precarious position."

Italy's 10-year bond yield jumped more than 8 basis points to 1.002%, its highest in more than two weeks. That pushed the closely watched gap over safer German Bund yields to almost 149 bps -- its widest since late January and up from about 134 bps on late Friday. Italy's benchmark stock index tumbled more than 4% and was on course for its biggest percentage fall since June 2016.

"Italy is facing a recession now and there is a good chance of a negative economic growth number in the first quarter, but we will have to see how the virus spreads from here," said Chris Scicluna, head of economic research at Daiwa Capital Markets. The surge in coronavirus cases outside mainland China triggered steep falls in stocks as investors fled to safe havens such as gold.

In bond markets, that translated into demand for top-rated bonds such as German Bunds, U.S. Treasuries, and British gilts. The yield on Germany's 10-year bond or Bund fell to -0.5%, its lowest in more than four months. The 30-year Bund fell below 0% for the first time since October, meaning the entire German yield curve was back in negative territory -- another sign that investors are bracing for a deteriorating economic outlook.

Eurozone money markets are now pricing in about a 50% chance that the European Central Bank will cut interest rates by 10 basis points in July, compared with 35% a week ago. And a key gauge of the market's long-term inflation expectations - the five-year, five-year forward - fell to 1.17%, its lowest since early October.

The 10-year Treasury yield, meanwhile, tumbled to 1.377% - its lowest since July 2016. The 30-year Treasury yield touched a record low at 1.829%. "The focus has effectively moved off China, where the data flow around coronavirus is improving, to elsewhere in the world and the effect on growth that the coronavirus will have," said John Davies, G10 rates strategist at Standard Chartered in London.