DE30: Italian yields rise as pressures surrounding budget mount

Summary:

• European stock markets trade slightly higher shortly after the opening shrugging off declines on Wall Street

• Italy’s 10Y yield spread over the German counterpart hits the highest level since 2013

• Wirecard (WDI.DE) jumps over 2% on the back of a recommendation as well as the upbeat news from Brazil

European equity markets seem to be playing down substantial declines seen on Wall Street on Thursday and a while after the opening most of them are moving above their yesterday’s close level. The exception is the Italian stock market which continues to be beleaguered by budget-related pressures. After the first 30 minutes of trading the Italy’s FTSE MIB (ITA40) is trading slightly below the flat line. The negative attitude to Italian assets is perfectly seen in the bond market when the 10Y spread over the German bund has widened beyond 330 basis points hitting the highest level since 2013. Why has the spread widened once again? What has been the direct cause behind it?

The Italy/Germany 10Y yield spread hits its highest level since 2013 on mounting pressures related to a budget draft. Source: Bloomberg

On Thursday two EU commissioners Dombrovskis and Moscovici wrote in a letter addressed to Italian finance minister Giovanni Tria that the 2019 budget draft constituted a direct breach of the EU rules. The Italian woes are also weighing on the euro as the shared currency is trading lower against the US dollar (below 1.1450 at the time of writing) mirroring the rising risk premium. Why did the EU challenge the Italian budget even as it does not assume breaching the 3% GDP threshold of deficit? Namely assumptions taken to the forecasts seem to be dubious given the fact that the European economy is likely to slow down after passing the peak of the business cycle earlier this year. Hence, taking into account some populist measures such as lowering the retirement age it is highly probable that the safety buffer - to avoid breaching the deficit exceeding 3% of GDP - could not sufficient. Yet, it needs to be said that Italy has the second highest public debt in the European Union and if it unable to lower it in an environment of sound economic growth it will not be able to do so in the future alike. This is the prime risk which investors are pricing in right now. Note that the Italian curve is currently placed above the junk European bonds yield curve (those rated at BBB or below) meaning that market participants have virtually pushed Italian bonds to the ‘junk pot’.

In the weekly chart of the DE30 one may notice that the price failed to come back to above 11900 points and it is highly unlikely it will be able to do so till the end of trading this week. As a consequence, the support of 11400 points could be tested before long and it could be a major test for bulls and for the entire stock market as this level constitutes the 50% retracement of the entire rally between mid-2016 until the start of this year. Source: xStation5

Looking into the breakdown of the German index we may single out Wirecard as the best performing stock this morning. This performance stems from two reasons. Firstly, the company’s subsidiary in Brazil announced today the launch of its payment services in that country. Thanks to this system all merchants in Brazil will be able to accept immediate card payments which in turn should improve the customer experience and eliminate the need of physical cash. Secondly, Wirecard could be still benefiting from a bullish recommendation from Guggenheim Securities which started covering Wirecard with a buy call. The price target was set at 218 EUR being well above the spot price of approximately 173 EUR. On the opposite site is Continental (CON.DE) being depressed by Michelin’s warning of declining sales in the second half of 2018 in Europe and China.

Wirecard (WDI.DE) and Continental (CON.DE) are placed among top movers in the DE30 this morning. Source: Bloomberg