Personal Wealth Management / Market Analysis

Don’t Judge a Country by Its Credit Rating, Italian Edition

Italy shows why we think credit ratings are a distraction.

In a widely watched move, credit ratings agency Moody’s recently raised its outlook for Italy to “stable” from “negative,” relieving the worries of many commentators we follow.[i] Supposedly, this removes the threat—a “sword of Damocles” even—of the agency downgrading Italy’s rating into non-investment grade—junk—territory.[ii] But in our view, all the bluster here was overdone. Whilst ratings agency pronouncements may swing sentiment in the short term, we don’t think the labelling changes a country’s fundamental ability to meet its debt obligations. Ultimately, we find that is what drives market moves longer term. Based on our observations, raters’ opinions tend to follow markets more than lead them, which this latest non-move illustrates well.

Judging by the headlines, you might think markets were on tenterhooks leading up to the proclamation. You see, in August 2022—following former Italian Prime Minister (and ECB President) Mario Draghi’s July resignation—Moody’s placed the country on negative credit watch, warning the new government could backslide on the technocratic Draghi government’s structural reform programme.[iii] The next month, populist Brothers of Italy leader Giorgia Meloni led her party to power in a government coalition, seemingly cementing concern they would blow out deficits, increasing default risk.[iv] And her recent budget plan, which boosts deficits beyond EU limits, only compounded chatter we heard ahead of Moody’s scheduled review.[v]

Italian 10-year interest rates did climb during much of September and October.[vi] The difference between Italy’s 10-year yield and Germany’s—the yield spread, a measure of perceived credit risk—widened.[vii] Many commentators we follow warned an even larger jump loomed if a downgrade to junk actually came. So Moody’s non-change earlier this month seemingly suggested to them Italy’s moment of danger had passed. Italy would remain at Baa3—the rater’s lowest investment-grade rung—with the release proclaiming: “Medium-term cyclical economic prospects continue to be supported by the implementation of Italy’s National Recovery and Resilience Plan, and risks to energy supplies have abated.”[viii] And the outlook shift to stable implies a downgrade isn’t as imminent as a year ago. Whew!

But markets tell a different story, in our view. As Exhibit 1 shows, the yield spread’s latest rise never put it near recent highs, sitting well below October 2022 levels. This may reflect familiarity with Meloni’s government—like how initial discomfort with Italian populists governing in 2018 – 2019 apparently faded amidst gridlock. Despite recent budget plans pushing deficits higher, her coalition hasn’t pursued the massive tax cuts or spending programmes alarming many analysts we read.[ix] Partly because, as coalition governments are wont, the Brothers of Italy’s partners couldn’t agree on them.[x] But spreads also seem to have narrowed as mounting recession (broad economic contraction) warnings last year dissipated (akin to post-lockdown Italy in 2020) in keeping with the rest of Europe. Despite 2022’s fuel price surge, recession didn’t ensue.[xi] In any case, we find markets moved mostly ahead of Moody’s views.

Exhibit 1: A Short History of Italian Credit

Source: FactSet, as of 27/11/2023.

So whilst yield spreads are susceptible to sentiment, Moody’s mood swings seem to matter much less. Another way to see this: Moody’s has rated Italy Baa3 since October 2018.[xii] Exhibit 1 shows the actual downgrade then came well after spreads jumped. This is the norm, in our experience. During the eurozone’s debt crisis in the early 2010s, we found ratings changes almost always followed spreads blowing out amidst major news. Greece’s 10-year yield spread against Germany’s ballooned from under 1 percentage point to over 6 points before S&P Global downgraded Greek debt to junk in April 2010.[xiii] On the flipside, spreads also narrowed to reflect Greece’s improved creditworthiness—and return to budget surpluses this year—long before the ratings agency’s decision last month to promote Greece back to investment grade.[xiv]

In short, we think investors care far more about issuers’ debt service ability than ratings—which Exhibit 2 shows Italy clearly has. Although Italy’s interest payments as a share of its tax revenues have grown the last couple years, through Q2—the latest data available—its debt service burden stands at just 16.3%, almost a third of its 1990s peaks. The nation has also pushed out average maturities from just over 3 years in the early 1990s to over 7 years now, according to the Italian Treasury.[xv] That helps mitigate near-term interest rate swings’ effects, in our view. If Italy didn’t default then, we have a hard time seeing why it would be more prone to now. It is nice that Moody’s seemingly agrees to an extent, but we doubt that is necessary.

Exhibit 2: Italian Debt Service Much Improved From Three Decades Ago

Source: FactSet, as of 27/11/2023.

[i] “Italy Exits Moody’s Junk Danger Zone in Big Win for Meloni,” Alessandra Migliaccio, Bloomberg, 17/11/2023. Accessed via Yahoo!

[ii] See note i and Moody’s, “Rating Scale and Definitions,” as of 27/11/2023.

[iii] “Moody’s Cuts Italy’s Outlook to ‘Negative’ From ‘Stable,’” Staff, Reuters, 5/8/2022. Accessed via the Internet Archive.

[iv] “Italy’s Right-Wing Bloc Wins Election: Five Questions for Markets,” Staff, Reuters, 26/9/2022. Accessed via the Internet Archive.

[v] “Italy Challenges EU by Using Deficit to Fund Election Vows,” Alessandra Migliaccio and Flavia Rotondi, Bloomberg, 27/9/2023. Accessed via Yahoo!

[vi] Source: FactSet, as of 27/11/2023. Statement based on Italy’s 10-year benchmark yield, 30/9/2023 – 31/10/2023.

[vii] Source: FactSet, as of 27/11/2023. Statement based on Italy’s and Germany’s 10-year benchmark yields, 30/9/2023 – 31/10/2023.

[viii] See note i.

[ix] “Meloni Can’t Stop Unnerving Italy’s Bond Investors,” Alessandra Migliaccio, Alice Gledhill and Giovanni Salzano, Bloomberg, 3/10/2023. Accessed via Yahoo!

[x] “Italy Challenges EU by Using Deficit to Fund Election Vows,” Alessandra Migliaccio and Flavia Rotondi, Bloomberg, 27/9/2023. Accessed via Yahoo!

[xi] Source: FactSet, as of 27/11/2023. Statement based on Brent crude oil price per barrel, Dutch TTF Natural Gas spot prices and Italian and eurozone gross domestic product (GDP, a government measure of economic output).

[xii] See note i.

[xiii] Source: FactSet, as of 27/11/2023. Statement based on Greece’s and Germany’s 10-year benchmark yields, 12/11/2009 – 27/4/2010. “S&P Downgrades Greece Ratings Into Junk Status,” Staff, Reuters, 27/4/2010. Accessed via the Internet Archive.

[xiv] Source: FactSet, as of 27/11/2023. Statement based on Greece’s and Germany’s 10-year benchmark yields, 20/2/2012 – 20/10/2023. “Greek Gov’t Budget Deficit Turns Into Surplus,” Staff,, 20/7/2023. “S&P Upgrades Greece to Investment Grade for First Time Since 2010 Crisis,” Staff, Reuters, 20/10/2023. Accessed via

[xv] Source: Italian Department of the Treasury, as of 27/11/2023. Weighted average life of government bonds, September 2023.

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