German debt yields settle at 1-week highs on gas supply hopes; Italy eyed

European government bond yields consolidated at one-week highs on Wednesday ahead of a planned resumption of Russian gas flows via the Nord Stream 1 pipeline on Thursday. European stock markets opened higher and the Traxx Europe crossover index, which measures the cost of insuring exposure to sub-investment grade European corporate high yield bonds, fell for a second consecutive day to its lowest level in more than three weeks as risk sentiment improved.

“The general mood in the market has improved due to the Nord Stream resumption news as the tail risks of an extended shutdown has faded and it is all eyes on the Italian situation now,” said Peter McCallum, a rates strategist at Mizuho Bank in London. Yields on benchmark 10-year German government debt stabilized at 1.27%, just below a one-week high of 1.31% hit on Tuesday.

Russian gas flows via the Nord Stream 1 pipeline are seen restarting on time on Thursday after the completion of scheduled maintenance, two sources familiar with the export plans told Reuters. If Russian gas supplies, currently the single biggest determinant for Europe’s economic outlook, were to seize up, economic activity could tumble by more than 6% in some countries the International Monetary Fund warned.

Market attention shifted to Italy where Prime Minister Mario Draghi will address the upper house Senate on Wednesday on a political crisis that could bring down his government and trigger early elections. Senators have been summoned for 9.30 a.m. (0730 GMT) and the result of a vote on the prime minister’s speech was expected by 7.30 p.m. (1730 GMT).

Unicredit strategists expect Draghi to receive support for his government and stay on as Prime Minister leading to a tightening in bond yields between German and Italian debt. “A positive solution to the crisis could lead to moderate tightening of the 10Y BTP-Bund spread, below 200 bps as a first target and possibly as low at 180 bps depending on the message from the ECB on Thursday,” they said.

The spread was trading around 205 bps on Wednesday. Outright Italian 10-year bond yields were at 3.34%, below a two-week high of 3.50% hit last Thursday.

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