May 30, 2018 / 2:10 PM / 7 months ago

Italy passes auction test a day after bond market drubbing

MILAN/LONDON (Reuters) - Italy auctioned five- and 10-year government debt with relative ease on Wednesday, a day after the worst selloff in its short-dated debt in 26 years raised some concerns about the country’s ability to finance itself.

Political ructions have sent Italy’s borrowing costs rocketing in recent days, and the country paid the most in four years to sell 10-year debt on Wednesday, reflecting the repricing of its debt by investors.

But the auctions went relatively smoothly.

The euro zone’s third biggest economy sold 5.57 billion euros (4.8 billion pounds) in bonds, narrowly missing the top of its targeted issuance range of 3.75-6.0 billion euros.

Demand was stronger for a five-year bond compared with a riskier 10-year issue. The auction was covered 1.48 times versus last month’s 1.39 bid-to-cover ratio, when the Treasury sold a much bigger amount of 9.25 billion euros.

“It was almost business as usual. Italy is not close to being shut out of the market,” said Jan von Gerich, chief analyst at Nordea in Helsinki.

“Prices were close to secondary market trading, so there was no need to pay a big premium - that was an encouraging sign.”

After Wednesday’s auction, analysts calculate the Treasury has covered around 53 percent of its annual funding needs of 390-400 billion euros, of which 240-250 billion euros is in bonds and the rest in short-term bills.

Italy’s 10-year benchmark bond fetched a 3.0 percent gross yield, up from 1.7 percent at the previous auction in late April. Rome sold 1.8 billion euros of the bond, below a maximum offered amount of 2.3 billion euros.

“The Treasury has decided not to meet bids that would have allowed it to hit the top amount, as yields above 3 percent were deemed excessive,” IG analyst Vincenzo Longo said.

The five-year auction yield rose to 2.32 percent, the highest since February 2014, versus 0.56 percent a month ago.

The recent selloff has hit shorter maturities the hardest and analysts said the sharp rise in yields had supported demand for the five-year bond.

SO FAR, SO GOOD?

Italy’s government debt situation is still manageable as its long debt maturity profile and improved economic fundamentals are supportive, ratings agency DBRS told Reuters.

“There is never a bad bond, there are only bad prices,” said Roberto Coronado, senior portfolio manager investment grade credit at PineBridge Investments.

“We are not yet at the point where investors refuse to lend money to Italy. If they had tried to borrow yesterday, it might have been harder. Today things were more stable.”

Despite yields spiralling higher in recent days, the situation is vastly different from 2011-2012 when the euro zone crisis risked sending Italy’s debt costs out of control.

Italy’s 2-year yield soared to 2.7 percent on Tuesday, posting its biggest one-day rise since 1992 and pushing the gap with 10-year yields to its lowest since late 2011. At the time, however, Italy’s two-year debt costs reached 7.8 percent at auction.

It is this backdrop that has put a spotlight on Italian debt sales, although there are some big differences now.

The European Central Bank’s bond-buying programme and higher domestic ownership of the debt buffer Italian bonds. Only a quarter of Italian bonds are in foreign hands other than the ECB’s.

Italy has also taken advantage of a period of low borrowing costs to extend the average remaining maturity of its debt, which now stands at around seven years.

That means that in a rising bond-yield environment, it would take much longer for market moves to feed through into the total cost of funding Italian debt.

“The extended average maturity of its outstanding bonds and a relatively undemanding issuance schedule for the rest of 2018 suggest that Italy is unlikely to face major refinancing problems in the near term,” said Seema Shah, global investment strategist at Principal Global Investors.

Still, analysts said with the political outlook far from certain, bond auctions next month would be watched closely.

Others said the real test could come when the ECB ends QE and Italy has to attract new bond buyers.

“I don’t there should be any problems with issuance later in the year, but if we see more days like yesterday, even normal auctions could become trickier,” said Nordea’s von Gerich

Reporting by Valentina Za, Elvira Pollina and Luca Trogni in MILAN and Dhara Ranasinghe and Sujata Rao in London; editing by Andrew Roche and John Stonestreet

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