Italy's 10-year bond yield heads for biggest monthly drop since 2013

Italy's 10-year bond yield experienced its most significant monthly decline since 2013, though it slightly rose as the year drew to a close.

The bond yields decline

The month witnessed a staggering 60 basis point (bps) drop in the Italian 10-year yield. Investors reacted to the euro zone's subdued inflation and the European Central Bank's conclusion of its tightening measures, foreseeing substantial rate cuts in 2024. This movement in yields corresponds inversely with price shifts.

Across the euro zone, bond yields saw marginal increases on Friday amid low trading activity during the holiday period.

The German 10-year benchmark, despite hitting a one-year low at 1.896 per cent on Thursday, rose by 5 bps to 1.994 per cent before the year's end. Meanwhile, Italy's 10-year yield saw a 3 bps increase, reaching 3.479 per cent.

Florian Ielpo, head of macro at Lombard Odier Investment Management, observed a cautious approach from investors amidst a market largely dominated by buyers following recent rallies in both the stock and bond markets.

Market optimism fuels expectations

The German 10-year bond witnessed a substantial 45 bps drop this December, the most significant since July 2022. With a cumulative decline of 57 bps throughout the year, it marked its most favourable performance since 2014, salvaging the fixed income market after two months of considerable rallying in November and December.

In light of cooler inflation and a softened tone from central bankers, investors have significantly raised expectations for ECB rate cuts in the upcoming year. Forecasts suggest an approximate 165 bps reduction in borrowing costs during 2024, with a strong possibility of the first cut as early as March, based on money market indicators.

Despite this, Emmanouil Karimalis, rates strategist at UBS, expressed scepticism about further yield declines. He cited increased government debt sales expected in the coming year, especially in January, historically a busy period for issuances, potentially exerting upward pressure on yields.

Italy's 10-year bond yield spread compared to Germany's stood at 162 bps, having narrowed to its lowest since June earlier in the week, indicating investor confidence in the euro zone's more indebted nations.

(with Reuters inputs)