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(Bloomberg) — An imaginable downgrade of Italy to “undesirable” prestige this week would be hugely symbolic, potentially consequential and highly controversial.
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The unprecedented picture of a Group of Seven economy with “substantial credit risk” can be presented simply through Moody’s Investors Service, whose Baa3 score for the country is at the lowest point of investment grade, with a negative outlook.
Any announcement on Friday would be the first assessment since Prime Minister Giorgia Meloni’s coalition pursued looser fiscal policy in September. This, in turn, caused Italian bond yields to spread over Germany – a key threat measure – to widen to 210 foundational issues for the first time. since January.
With the spread back below 190 basis points, investors don’t expect a deterioration, especially as Moody’s rivals are less pessimistic about the country. But that doesn’t make the date of the next calendar any less precarious.
A relief in bonds would be a “shock to an already fragile market,” said Rohan Khanna, head of euro rates at Barclays Plc.
Italian bonds rose on Monday morning, outperforming their German counterparts and narrowing the spread between 10-year yields on 3 base issues to 183 core issues.
Barclays’ Khanna believes a downgrade could simply boost the spread to 250 foundation issues, a point that was last noted in the 2022 snap election that brought Meloni to power. Any rise in yields could put pressure on European Central Bank officials to curb the turbulence.
While a budget might exclude holding junk bonds, a simple valuation can also simply limit the damage, and investors have had time to prepare. But a seismic reaction is ruled out: Moody’s analysts know that Greece’s first downgrade to junk bonds in 2010 – via the corporate now called S
“They have no incentive to lower their score further,” said Zsofia Barta, an associate professor at the University at Albany and co-author of Rating Politics, an e-book on sovereign credit. “The last thing rating agencies need is something like a spiral kind of thing where anything scares the market. They don’t have to be the cause of the problem.
Moody’s might avoid releasing anything, but there is one case we need to keep an eye on. The negative outlook was announced in August 2022. Historically, the average time a borrower can wait to receive a prestige replacement is about a year. And even if Waste is a conceivable way out, as is the respite of a solid perspective.
Italy’s assessment of the score will follow Moody’s resolution on Friday to downgrade its outlook on the U. S. Aaa rating, the investment score, from solid to negative.
Public finance
Moody’s has highlighted three challenge areas for Italy. The first two fear structural reforms and challenges in energy sources, on which the Meloni government can claim that progress has been made.
Public finances are the biggest concern: according to Moody’s, “there are dangers that Italy’s fiscal strength will weaken further due to sluggish growth, higher financing costs, and potentially weaker fiscal discipline. “
In terms of those elements, things haven’t gone very well. Italy has just escaped a recession, the ECB’s interest rate hike has boosted loan prices, and Meloni’s 2024 budget has been described through Fitch Ratings, a rival to Moody’s, as a “significant easing. “
The government does not expect a major surplus next year, when revenues would exceed pre-interest spending, and the deficit will not return to the European Union’s 3% limit until 2026.
Moody’s tends to focus on debt as a percentage of gross domestic product. Italian production will still exceed 140% of output in five years’ time, according to the International Monetary Fund’s forecast last month, more than 8 percent more than expected in April.
“The simplest component for Italy to reduce the debt-to-GDP ratio is us,” said Dario Messi, Julius Baer’s steady revenue strategist. “There are still demanding primary situations ahead. “
It is significant, however, that Moody’s takes a more pessimistic view than its competitors. Fitch
“I think it’s very unlikely that Moody’s needs to do that, and especially do it itself,” Barta said. “They’re an outlier right now. “
Reducing Italy to trash may also seem complicated compared to other G7 economies. Its debt ratio is well below Japan’s 255% of GDP, which Moody’s estimates several levels higher. The UK and France have even higher ratings, but much higher debt ratios. One hundred percent – and their own tax defaults.
Unlike Britain, whose former Prime Minister Liz Truss revealed unfunded tax cuts that sparked a backlash from markets in 2022, Italy has not tested investors as boldly. At the same time, the country has been more successful than France in raising the retirement age in order to contribute to the sustainability of its pension system.
But unlike Italy, the UK and Japan take advantage of the flexibility of their own currency. This is where the ECB’s role will be important: officials in Frankfurt have a crisis tool ready to curb the turbulence, but one that would force the Italian government to submit. to the exigencies of foreign policy.
The central bank, of course, would prefer not to use it, one of the reasons it pleads with governments in the region to limit their borrowing.
“Fiscal policy aims to make the euro economy more productive and gradually reduce the peak of public debt,” ECB Vice President Luis de Guindos said on Monday.
However, the ECB would possibly be needed if Moody’s does indeed cut rates. The fact that few investors seem to anticipate a downgrade would add to the additional volatility.
“I don’t think anyone expects them to be undesirable,” said David Zahn, head of European bonds at Franklin Templeton, which is underweight Italian bonds. “It’s not that Italy is going to default, it’s not that Italy is going to leave the euro. What’s more, is the value of the foundation’s 200 issues correct?I would say no.
With loan prices at their highest point in more than a decade, a downgrade would inevitably spark a new discussion about its ability to meet its debt obligations.
“The market is like that,” Messi told Julius Baer. This brings back the debt sustainability factor, even more clearly than it already is today. “
–With those of Yuko Takeo and Chiara Albanese.
(Updates to Moody’s U. S. credit rating outlook)U. S. Citizen Security (11)
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