Fitch surprised by cutting Italy's credit outlook to negative from stable - BBH

Research Team at BBH, suggests that while most were looking out for DBRS credit review of Portugal, Fitch surprised by cutting Italy's credit outlook to negative from stable. 

Key Quotes

“At the heart of the decision was concern about the repeated delays and back loading of fiscal consolidation.  The disappointing growth, the non-performing loan burden, and the political climate pose downside risks.

Italian bonds, which had been underperforming Spain bonds, had then begun holding their own.  Last week, the benchmark 10-year bond yield fell 2.5% in Italy but rose slightly in Spain.  The divergence was sufficient to change the month-over-month performances back into Italy's favor (+18.5 bp vs. Spain's +19.7 bp).  Fitch noted that even if Renzi does not resign if the referendum fails, the government may be weaker.  Parliamentary elections are scheduled for May 2018, and Euro-skeptic political forces are on the rise (5-Star Movement won Rome and Turin in elections earlier this year).

The surprise action by Fitch, coupled with EU demands that Renzi alters the draft budget, may weigh on Italian bonds.  Italian bank shares rallied for three consecutive weeks, including a sharp 7.3% advance last week.  They may also be vulnerable if yields continue to rise.  Recall that DBRS put Italy on credit review with negative implications in August.  DBRS is the only one of the top four rating agencies that puts Italy in the "A" band.  A cut would increase the haircut the ECB imposes on Italian bonds used as collateral for loans.  The underperformance of Italian bonds relative to Spanish bond may resume if Spain is able to avoid a new election before the end of the year.  

Separately, we note that the average of the last 10 referendum polls in Italy with 1000 or more people surveyed was 35.3% supporting the change of the Senate and 41.5% opposed.  Most recently, former (unelected) Prime Minister Monti came out last week siding with the No's, as has a wing of Renzi's own party and the leaders of all the opposition parties.”