Draghi effect pushes Italy-Germany gap to lowest in 5-years

MILAN/LONDON: Italy's 10-year government bond yield headed for its biggest weekly drop since July on Friday, while the gap over the German yield narrowed to its smallest in five years as ex-European Central Bank chief Mario Draghi began talks to form a new government.

Trade in euro zone debt markets was generally subdued at the end of the week. It was little moved by data showing US employment growth rebounding moderately in January, in line with forecasts and which economists said bolstered the case for more government relief money.

Global shares approached record highs as progress in vaccine distribution and the hopes for US stimulus prompted bets on further normalisation in the global economy.

That backdrop boosted sentiment towards riskier assets such as peripheral European bonds, with Italy set to end the week on a high following this week's political developments.

Draghi, given a mandate to form a new Italian government, will end a round of consultations on Saturday. It is still unclear whether he can win the support of the anti-establishment 5-Star Movement, the largest party in parliament.

Italy's 10-year BTP, or government bond, yield fell as far as 0.51%, its lowest level since Jan. 11, before rebounding to 0.54% It is down more than 10 bps this week.

The Italian/German 10-year yield spread narrowed to around 94 basis points, the least since early 2016.

"We've seen how the market doesn't just like Draghi, it loves Draghi and foreign investors are supporting the rally in BTPs," said MFS fixed-income research analyst Annalisa Piazza.

Piazza said room for further spread tightening was limited, although Italy could see further outperformance over euro zone peers if a Draghi government successfully implemented his programme in the medium term.

"Markets are pricing in a government led by Draghi. But even if the former ECB head were unable to form a government, we would see a sell-off in the short term that would translate however into a compression of interest rates in the long term," said Althea Spinozzi, fixed income strategist at Saxo Bank.

UniCredit analysts added that further spread compression in Italy would likely depend on the extent of parliamentary support for the government and foreign investors' "willingness to increase their exposure to the BTP market again."

They said the 2015 lows of 88 basis points between the German and Italian yields "do not seem to be out of reach."

Bond yields also eased in Spain and Portugal .

News of a fall in German industrial orders in December put brief downward pressure on German yields.

But Bund yields soon headed higher, with the benchmark 10-year note touching its highest level since early September at -0.413% and putting it on course for its biggest weekly jump since August.