Ciao!

As anyone who has holidayed in Italy knows, this little word can mean hello or goodbye and is widely used in other cultures too.

Recently Italian bond markets made the financial news and it was very much a quick hello and good bye.

The political situation in Italy looked all of a sudden to be very shaky and ‘spreads’ on Italian bonds or loan stocks shot up.  In fact there was moment when global stock markets started speculating about a new Eurozone crisis.

What does it mean when ‘spreads’ move up?  It means that the difference between the interest rate investors expect to be paid to lend to the country of Italy (in this case) and its institutions and businesses, relative to the rate they require to lend to say the UK or US or Germany,  move up to reflect perceived extra risk.

For example, say an Italian bank was offering a 5% return on a fixed term bond the last time it borrowed money from the money markets, but now no-one will buy the bond unless it pays 6%.  In that case the spread has gone up 1% or 100 bps (basis points), assuming all other countries are borrowing at the same price as before.

The change in Italy mattered a lot to some investors running bond funds.   Italy is large industrialised country with some great businesses (not just food, cars and wine!)  but it has not got  a great reputation for security and stable government and so bond fund investors have been happy to own Italian loan stocks and pick up a bit more return that reflects the lower credit quality than say Germany.  But imagine you bought Italian bonds at prices that on average are giving you a 4% return in total if held to maturity.   If spreads shoot up the market might want 6% or even 7% returns over the period during which you are going to have to wait for your bonds to mature.  That makes your bonds very unattractive and in fact their value as a tradeable asset will have fallen very significantly overnight.

In the end a new pro Euro government has been installed, albeit the first really different government in Europe since the Greeks rebelled against austerity.  Markets calmed down, but expect to be hearing more about Italy in the financial as well as the culinary media!