Rates Spark: Treasuries out of favour

Since the weekend agreement with China, we've turned bearish on Treasuries, as the recession risk has been downsized, and there's been a risk-on tone in the risk asset space. Also, we note that mutual funds had been setting short duration strategies over previous weeks, which had not shown up in prior yield movements. So an up-move in yields was overdue. The fiscal story is something that continues to hang over the market, and the tax cutting ambitions are, if followed through on, seen as a Treasury market negative. That's been an ongoing thing churning in the background. Not new. But absolutely lined up as a negative. It's been quite a move. In the past five trading days the 10yr yield is up some 25bp. No "Sell America" thing going on here. More a fair reflection of fundamentals.

The 10y spread of Italian government bonds over German Bunds hit 100bp on Wednesday, its tightest levels since 2021. The de-escalation on the trade front has helped risk sentiment with Italy regarded as one of the more exposed nations within Europe. But we have clearly already surpassed levels seen even before 'Liberation Day'.

It could point to a more broader trend in the wake of the US induced turmoil - that of greater diversification away from US exposure. German Bunds have been a clear beneficiary, but even Italian bonds appear to benefit. Italian treasury officials have recently remarked to MNI that they had seen better-than-expected demand from foreign investors for their bond sales this year. The Bank of Italy's portfolio flow data for the first months of the year show higher inflows from foreigners into Italian government debt, but data does not yet cover the recent episode of market turmoil caused by 'Liberation day'.

In recent years the Italian treasury's strategy to stabilise its funding position has also been an increased reliance on the domestic retail investor. The share of debt instruments tailored to this end tops 6% and thus surpasses Italy’s financing via treasury bills. The next retail BTP-Italia bond is planned for later this month. With foreigners seemingly staging a larger-than-anticipated comeback into Italian debt, Italy might rethink its funding mix again, which officials suggested could be a consideration for next year. Overall though, it points to spreads remaining supported even at their currently tight levels.