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Political worries about Italy and Spain grip markets

posted onMay 29, 2018
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The financial markets were jittery on Tuesday with investors spooked by political uncertainty in Italy and Spain. Stocks dropped sharply, the euro fell against the dollar and Italian bond yields climbed.

Stoxx Europe 600, the Paneuropean benchmark index, fell 1.3% in early trading, led lower by a 2.5% fall for both Italy's FTSE MIB and Spain's IBEX 35 indices. FTSE MIB, which earlier this year was one of the best-performing major stock markets in Europe, has now erased its gains for the year.

The euro struggled near 6-1/2 month lows holding at $1.1630 from Monday's $1.1608, its lowest since early November. On a monthly basis, the single currency has fallen more than 4 percent and is set for its biggest monthly drop in more than three years, according to Thomson Reuters data. 

The Italian two-year bond yield broke through 2 per cent for the first time since 2013, reaching as high as 2.442 per cent,  in a sign of falling confidence among investors.The yield on 10-year debt hit 3.388 per cent.

italian bond yields

(The size of today's move in Italian bond yields, the likes of which haven't been seen since Europe's sovereign debt crisis Graphic: Bloomberg with IP)

Italy has been without a government since an inconclusive vote on March 4, because no political group could form a majority. Eurosceptic, anti-migrant League and anti-establishment 5-Star Movement (M5S), emerged as two of the biggest parties. 

But talks between the Italian President Sergio Matarrella and M5S and League parties on the cusp of forming a new government led by law professor Giuseppe Conte fell apart, as the head of the state at the weekend vetoed Conte's nomination of  Paolo Savona, a 81-year-old eurosceptic economist as economy minister.

Mattarella, who  considered Savona a threat to Italy’s position in the eurozone, then named Carlo Cottarelli, a former International Monetary Fund official to lead a technocrat government, with the task of planning for snap polls and passing the next budget.

us dollar euro

(The euro fell against the dollar- its lowest since early November Graphic: Marketwatch with IP)

The President’s decision to block formation of a eurosceptic government reignited the debate over Europe’s future, including whether the eurozone’s third-largest economy with 2.3 trillion in debt
should remain in the currency union. Financial markets fear a snap election will turn into referendum on Italy's euro membership and strengthen the country’s anti-establishment parties even further. 

Mattarella's move prompted a furious reaction from League leader Matteo Salvini, who accused the president of representing the interests of other states instead of Italy, and M5S leader Luigi Di Maio, who has called for the head of State's impeachment according to ANSA news agency.

Cottarelli is widely considered unlikely to win a vote of confidence. The M5S and the League are certain to vote no, as is the rightwing Brothers of Italy (FdI) party, which has also called for Mattarella's impeachment. 

Di Maio, also called for a mass protest on June 2, a national holiday, saying citizens should insist on their right to choose their leaders.  “Last night was the darkest in the history of Italian democracy,” he said on Monday referring to the President’s decision to reject the nomination of their economy minister.

Salvini said: “It’s madness, and I ask the Italian people to stay close to us because I want to bring democracy back to this country.”

On Monday, after receiving the mandate to try to form a government, Cottarelli said his primary job was to guide Italy to a new election. He also urged calm and tried to reassure investors. 

“The Italian economy is still growing and public finances are under control,” he said. “Dialogue with the EU to defend our interests is essential and we can do better but it has to be constructive.”

What are analysts saying?

"Cottarelli will fail," Wolfango Piccoli, co-president of Teneo Intelligence, told CNBC's "The Rundown" Tuesday. "If the desire of the president was to try and calm down markets by appointing a former IMF official, I think his plan might have failed," Piccoli added. 

National Australia Bank said in a commentary: "Fears of a euro existential crisis are gathering momentum amid simmering political turmoil in Italy." 

“The crisis in Italian politics deepened over the weekend. Repeat elections in early autumn now look likely. ... Stay risk averse for now, would be our recommendation” Marketwatch cited a team of RBC strategists as saying in a note Tuesday. 

“The spillover effect on the euro from the Italian bond markets is limited for now but that can change if the selloff forces investors to dump other peripheral debt,” said Viraj Patel, a currency strategist at ING in London told Reuters. 

More market turmoil ahead

But the weakness in Italian markets has begun to feed through into other eurozone periphery nations’ debt yields. Although Portugal's economy is growing at the fastest pace in almost two decades, the country's bond spreads are widening along with Italy's. The 10-year Portuguese yield is up 31bps. 

Adding to heightened uncertainty,  Spanish Prime Minister Mariano Rajoy will face a vote of confidence in his leadership this week as allegations of corruption against members of his center-right People’s Party (PP) threaten his rule.

The vote was proposed by the opposition Socialist Party after the results of a long-running corruption trial were announced on Thursday, in which 29 people linked to the PP were convicted of crimes such as embezzlement and tax evasion 

The Spanish 10-year yield is up 14bpon the day. 

Italy, a founding member of the EU and the euro has a debt-to-GDP ratio stood at 133 percent in 2017, according to the International Monetary Fund. Italy's banks hold around 345 billion euros ($425 billion) of debt and are considered a proxy for sovereign risk. Meanwhile, ratings agency Moody's has also put Italy's sovereign rating on watch for a downgrade. Eurozone is facing its biggest upheaval since the Greek debt crisis.