Italy’s bond market is in meltdown, its politics in crisis after President Sergio Mattarella blocked the formation of an antiestablishment government and its credit rating under threat.
That is all now making bigger waves: Europe’s deepening troubles and disappointing global growth signals are sparking a sudden rally in haven bonds like U.S. Treasurys. Risk aversion is back.
The moves are notable because haven bond yields have until now shown little reaction to the creeping tide of unsettling news that has emerged in 2018. The overwhelming focus has been on how far and fast yields might rise, particularly in the U.S.
Instead they are falling rapidly. The 10-year German Bund yield now stands at just 0.19%, more than halving in the past two weeks and its lowest since early 2017. Last week alone, the yield racked up its biggest one-week fall since mid-2012, when the eurozone sovereign-debt crisis was still raging, according to FactSet. Ten-year U.S. Treasury yields have also dropped well below 3% again.
In the eurozone, the move in German yields makes the selloff in Italian debt look even more extreme. The gap between 10-year German and Italian bond yields—a key indicator of market stress—has now risen above 2.5 percentage points, its widest since 2013.
In the U.S., the move may put renewed focus on the flattening of the Treasury yield curve, another potential sign of economic distress, since short-dated yields are supported by expectations of further Federal Reserve rate increases.
Worries that Italy could cause the eurozone to fragment are also pushing up the dollar, adding further momentum to a move that has already caused turmoil in emerging markets. The euro has fallen to its lowest since July, below $1.16.
Along with the currency, bond-market returns have flipped, likely wrong-footing investors. German bonds are now up 1.3% on the year, while Italian bonds are down 3%. Treasurys gained 0.8% last week, their best performance so far this year.
Italian bonds and stocks are just the latest in a string of risk-seeking trades that have run into trouble in 2018. It may be some small relief that haven bonds are now providing an offset. However, it is also a sign that the benign conditions that prevailed for investors until recently are under heavy fire. The market ride is set to get bumpier.