Markets

Italy's CDS markets price in super-sized sovereign credit rating cut

Key Points
  • A gauge using CDS levels compiled by S&P's Capital IQ analytics unit, known as a Market Derived Signal Score (MDS), now puts Italy's government debt at a B+ rating rather than its current actual "investment-grade" BBB.
  • S&P and rival Fitch currently have "stable" outlooks on their BBB Italian ratings, which means no move is currently seen.
Artisans and merchants gathered in Rome to demand that Parliament the new government in the midst of being formed make an urgent breakthrough in economic policy after the economic crisis shut down more than 372 000 businesses in 2013.
Kevin Winter | Getty Images

Italy's political turmoil has left Credit Default Swap (CDS) markets pricing in a super-sized sovereign rating downgrade, which, if it happened, would push the country deep into "junk-grade" territory.

A gauge using CDS levels compiled by S&P's Capital IQ analytics unit, known as a Market Derived Signal Score (MDS), now puts Italy's government debt at a B+ rating rather than its current actual "investment-grade" BBB.

It is a five-notch difference on the rating scale and is the biggest gap between the two scores since mid-2012, when worries about a break-up of the euro zone were at their peak.

S&P and rival Fitch currently have "stable" outlooks on their BBB Italian ratings, which means no move is currently seen.

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Moody's, however, which gives Italy its equivalent level of Baa2, put the country on a review on Friday for a possible downgrade.

MDS levels can often be an indicator of future rating moves, but volatile market pricing can also result in big overshoots that do not materialize.

A downgrade to "junk" would be extremely damaging. Without special measures it would stop Italian debt being used as collateral in the European Central Bank's main lending operations, which commercial banks use to source funding.

They could potentially use a separate emergency facility but commercial banks are often downgraded in tandem with their government, meaning their own credit scores would also see a sharp deterioration.