The big issue, in our view, is not the threat from the EU authorities but rather the risk that Italian government debt is downgraded to sub-investment grade. Italy is currently rated two notches above sub-investment grade across the three main ratings agencies (S&P, Moody’s and Fitch). In August, Fitch followed Moody’s in adjusting the outlook for Italian debt to negative, escalating fears that they may follow through with a downgrade. At this juncture, it seems unlikely that either agency would downgrade Italy by two notches, whilst S&P has thus far taken a more sanguine approach, appearing to focus more on long-term dynamics. The 2.4% budget deficit initially proposed by the new Italian government was certainly on the high-end of expectations but it is worth putting this in the context of being well below the 6% number bandied about earlier in the year. The main risk appears to be both a downgrade whilst maintaining a negative outlook, leaving the market nervous regarding further downgrades to sub-investment grade.

Should two of these three agencies downgrade to sub-investment grade, many benchmarked investors (including the widely followed Bloomberg Barclays Global Aggregate) would be forced to liquidate holdings. We can be sure that markets will be volatile but overall, again, we think investors are reasonably well compensated for risk in Italian assets.