Analysis: Cracks starting to appear in solid Italy bond market

Fri Mar 15, 2013 8:32am EDT
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By Marius Zaharia

LONDON (Reuters) - Chinks are showing in the Italian bond market's resilience to the political stalemate that followed last month's election.

Backstopped by the European Central Bank's bond-buying pledge, Italian yields have been relatively steady at levels well below their all-time highs since the Feb 24-25 vote which left parties deadlocked over how to form a government.

But some potential signs of market stress are emerging.

Italian bonds paying lower rates of interest have outperformed higher-coupon paper of similar maturity in recent weeks - a phenomenon that occurs in times of heightened uncertainty, when investors take defensive positions.

"It is one of the crisis barometers," said Commerzbank rate strategist David Schnautz. "When you have stress in the system you see certain dislocations, switches in the curve."

While yields on the two types of bonds are similar, those offering smaller coupon payments are generally cheaper to buy, reducing the potential loss for the investor if the issuer cannot repay its debts.

A sovereign borrower with liquidity problems would also be more likely to delay coupon payments than not redeem the bond at maturity, analysts say.

The discrepancy in price is most visible at the longer end of the Italian debt curve, where the difference between coupons is also wider.   Continued...

People walk past the Duomo cathedral in downtown Milan January 11, 2013. REUTERS/Alessandro Garofalo