Benchmark Italian bond yields rose on Tuesday after the European Commission, the executive arm of the European Union, told Italy that its original draft budget proposal was rejected. However, Italy has three weeks to make adjustments to the budget and resubmit it to the European Commission for review.
The European Commission Vice-President for the Euro and Social Dialogue Valdis Dombrovskis said in a press statement there was no alternative but to reject the initial proposal as is.
“Unfortunately the clarifications were not convincing to change our earlier conclusions of particularly serious non-compliance,” said Dombrovskis. “The Italian government is consciously and openly going against commitments made.”
“Breaking rules can appear tempting at a first look, it can provide an illusion of breaking free. It is tempting to cure debt with more debt, but at some point the debt weighs too heavy,” he added.
This marks the first time that the European Commission rejected a draft budget proposal by a member country, which helped send the benchmark Italian 10-year bond to its current level of 3.596%.
source: tradingeconomics.com
Per a report, European commissioner Pierre Moscovici already expressed his discontent at the Italian government, saying “the Italian Government presented a government budget with a 2.4% deficit not only for this year but over the next three years to come which is a significant deviation to what was committed before. It may lead to public expenditure that makes you popular for a while, but who pays in the end? The European Commission will exert all of its powers not to impose austerity but in the defense of the Italian and European interests.”
The Italian government sent European markets in a frenzy due to comments from Claudio Borghi, who heads economic policy for the ruling Lega party, saying the country would be better off if it wasn’t tied to a single currency, the euro, and operated on its own currency.
“I am truly convinced that Italy would solve most of its problems if it had its own currency,” Borghi said in a radio interview, Reuters reported.
The situation in Italy is already reminiscent of the economic crisis that sent Greece and the entire Eurozone reeling–a roller coaster ride that European Commission president Jean-Claude Juncker was happy to go on just once.
“One crisis was enough,” said Juncker. “After the toughest management of the Greece crisis, we have to do everything to avoid a new Greece–this time an Italy–crisis.”
Related: Italy Troubles Keep Pressure on Euro ETFs
Italian bonds have faced mounting pressure the last few months since the anti-establishment coalition of the right-wing League and the 5-Star Movement took over office in June. Last year, Italy recorded a government debt equal to more than 130% of the country’s gross domestic product, but has struggled to keep its repayments under control.
“There’s been a lot of noise around Italy, but I think the key question to focus on is not the rounding around the budget numbers that they are predicting or forecasting, but more this perception of whether the relationship with Europe is cooperative or whether it is disruptive,” said George Saravelos, global co-head of FX research at Deutsche Bank.’
U.S. Investors opt for Short Duration
As volatility is on the rise in the U.S. stock market indexes, investors are wanting to reduce exposure to the capital markets and this may be manifesting itself in fixed-income products. Investors can get short duration exposure with ETFs like the SPDR Portfolio Short Term Corp Bd ETF (NYSEArca: SPSB), which seeks to provide investment results that correspond to the performance of the Bloomberg Barclays U.S. 1-3 Year Corporate Bond Index.
SPSB invests at least 80 percent of its total assets in securities designed to measure the performance of the short-termed U.S. corporate bond market. Ideally, shorter-term bond issues with maturities of three to four years are ideal to minimize duration exposure should the bull market enter a correction phase.
Another short-term bond ETF option is the iShares 1-3 Year Credit Bond ETF (NASDAQ: CSJ), which tracks the investment results of the Bloomberg Barclays U.S. 1-3 Year Credit Bond Index where 90 percent of its assets will be allocated towards a mix of investment-grade corporate debt and sovereign, supranational, local authority, and non-U.S. agency bonds that are U.S. dollar-denominated and have a remaining maturity of greater than one year and less than or equal to three years–this shorter duration is beneficial during recessionary environments.
“In fixed income, it was more of the same, with good buyers of ultra short duration products,” said Brian Gilman of ETF Sales & Trading at Virtu Financial.
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