Credit diverges in the periphery

It was a tale of two auctions on Wednesday as the credit divergence in the periphery was laid bare.

Italy faced a relatively tough challenge when it sold debt this morning. It was the first auction since it was downgraded to Baa1 by Fitch last Friday, not to mention the uncertainty fuelled by the seemingly omnipresent political turmoil.

Nonetheless, even with low market expectations the sovereign still managed to disappoint. The Italian Treasury only raised €3.3 billion in the auction for bonds maturing in December 2015, short of the maximum target of €3.5 billion.

Demand was weak, as indicated by the bid-to-cover ratio, and domestic accounts probably provided the majority of bids. An auction for a 2028 bond was better, but overall the result was lacklustre.

Italy's CDS widened 13bps to 273bps, though this is still about 20bps tighter than the post-election levels last month.

The contrast with fellow peripheral Ireland couldn't have been starker. Ireland's Finance Minister Michael Noonan described the 10-year benchmark bond sale today - the first since the EU bailout more than two years ago - as "extraordinary".

Political hyperbole aside, the auction was indeed impressive. Ireland received about €12 billion bids in 400 orders, according to Noonan, and €5 billion was sold at a yield of 4.15%.

The deal is a landmark for Ireland and puts it well on its way to exiting the bailout as planned by the end of this year. Ireland's CDS widened slightly to 167bps, but this was no surprise given the new supply coming on to the market.

To put it in context, Irish sovereign CDS were trading at well over 1,000bps in July 2011, and were more than 800bps wider than Italy. Now, the latter is the laggard - trading 100bps wider than Ireland.

Italy's weak bond auction led to Italian banks being among the worst performers today. One bank that did buck the widening trend was Commerzbank, which saw its spreads rally by 6bps to 140bps after it announced a larger than expected capital raising plan. The capital increase will be funded through a rights issue - bad news for shareholders, but good for bondholders.

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