Goldman: Rate Relief Needed For European Sovereign Spreads

Goldman Sachs note that “the recent global duration sell-off has exposed a fault line in European sovereign credit. This has coincided with a deterioration in fiscal fundamentals in Italy, with the debt-to-GDP ratio now likely to be on an increasing path in coming years.”

• “In our view, short-term stabilisation of BTP-Bunds spreads will require lower rates volatility, in part through increasing confidence that the disinflation path is secure, and relief from global yield increases.”
• “We believe that path is possible but narrow and, given that spread stability will itself increase the risks of faster ECB QT, we continue to expect sovereign spreads to widen, albeit more gradually, as the market reassesses fiscal risks globally.”
• “In particular, if market concerns for fiscal risks globally do not subside – including in the U.S. – Italy is likely to remain in focus.”
• “We continue to expect the 10y BTP-bund spread to widen towards our 235bp target, though more gradually than in recent weeks.”
• “We are more constructive on Bonos, which have been dragged wider against Bunds without a comparable deterioration in fundamentals.”
• “Finally, we continue to think that ECB QT will lead to further German swap spread tightening, and we continue to forecast German 10y yields at 2.75%.”
• “However, a sharp and rapid widening in sovereign credit spreads from current levels would likely lead to a correction lower in core yields.”