Italy leads eurozone bond rally, 10-yr yields hit record low as new govt agreed

Italy's 10-year bond yield briefly fell to a record low below 1% on Wednesday on growing hopes that a new government will soon be formed and a new election averted.

The rally in Italy led bond market gains across the eurozone, with global recession concerns and further Brexit uncertainty driving Germany's 10-year yield to plumb a new record low beyond minus 0.72% and pushing the entire Finnish yield curve sub-zero. In Italy, headlines pointing to a deal between the ruling 5-Star Movement and opposition Democratic Party (PD) to form a new government gave investors the green light to rush for Italian debt, which carries higher yields than the 'core' eurozone countries.

PD Nicola Zingaretti told Italian President Sergio Mattarella his party was ready to try to form a government with the 5-Star Movement. Zingaretti then told reporters his party was also ready to accept 5-Star's candidate for prime minister - the current premier Giuseppe Conte.

"Our baseline assumption is that a green light will come for some kind of new government," said Chris Scicluna, head of economic research at Daiwa Capital Markets. A new coalition government implied a "more sensible fiscal policy" in the near term, Scicluna said; a government led by Matteo Salvini of the League party, on the other hand, would have created conflict with the European Union.

Italian bond yields fell seven to 15 basis points across the curve. Two-year bond yields briefly fell to their lowest since May 2018 at -0.22%, while 10-year yields fell to a record low below 1% The yield on 50-year bonds hit a record low around 2.266% before reversing marginally.

While analysts expect the BTP rally to continue, especially if the ECB delivers stimulus next month as expected, they are aware the potential coalition will be fragile. "If there is anything negative with respect to the working of the coalition, it could really spike the Bund-BTP spread again," Pooja Kumra, European rates strategist at TD Securities, said referring to Italy's yield premium over German debt,

The yield spread is now at the narrowest since last May around 174 bps, However, the Italy optimism failed to dent demand for safe-haven German bonds, which were supported by trade war concerns and the growing likelihood of a chaotic no-deal Brexit.

Germany's benchmark 10-year briefly fell to a new record low at -0.728%, while Finland's 30-year bond yield fell to -0.024%, pushing the country's entire yield curve into negative territory. The Eurozone bond rally was part of a global picture.

The U.S. Treasury yield curve - as measured by the gap between two and 10-year bonds - inverted the most since 2007 on fears the trade tensions will tip the economy into recession. The curve is widely regarded as a recession indicator. Japan's 30- and 40-year bond government yields hit three-year lows earlier.

British government five-year bond yields plumbed the lowest since October 2016 after Queen Elizabeth gave the nod to Prime Minister Boris Johnson's move to effectively shut parliament from mid-September for around a month, to curtail its ability to derail his Brexit plan.. "The rally in bonds in the U.S. and Europe is continuing because expectations for a trade deal are moving further away," said Antoine Bouvet, senior rates strategist at ING in London.

"The unpredictability of the trade conflict might push investors to price the worst outcome until they receive evidence that it can be avoided." In primary offerings, Germany sold 2.336 billion euros of 10-year bonds later, while Finland garnered strong demand for a new five-year bond, which priced at a deeply-negative rate via a syndicate of banks.

Orders for the new bond were nearly 14 billion euros, close to five times the 3 billion euros raised, according to the Finish state, which said the bond was priced to yield -0.734%. TD Securities's Kumra said such offerings were seeing a high level of demand despite a deeply negative yield as they still offer a pick-up versus Bunds.

"These syndications will be well absorbed as long as they see the support delivered by central banks that are being priced in," she added.

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