Lost The Dot Plots
Clearly the decision by Italian President, Sergio Mattarella, to refuse the appointment of Paolo Savona as the coalition’s Finance Minister, on the grounds of him being overtly eurosceptic, has backfired badly. The decision has been used by the coalition parties to show the establishment as being anti-democratic and has stoked the market’s fears that this will only add support to the populist movement in Italy, and maybe other eurozone members. Mattarella’s hope that the appointment of Carlo Cottarelli as PM to form a stabilising technocrat government looks doomed and unlikely to survive a vote of confidence in the Italian parliament, which of course could lead to another election later in year. As a result there was a rout yesterday in Italian government BTPs, with the 10yr yield breaching 3% and the spread vs Bunds briefly nudging 300bps (almost twice the spread of a year ago) with the contagion spreading to Italian equity and debt markets and subordinated bank bonds selling off up to 5-6 points in early trading.
Markets do not like uncertainty and this scenario is full of potential outcomes, some of which are very unfavourable. Italy is after all the third largest economy with the largest debt in the eurozone. With this in mind the move in BTPs was understandable, but it begs the question what next? Will the Italians allow the turmoil to continue without some efforts to stabilise the situation and will the euro-institutions merely sit on the sidelines and watch potential cracks appear at the very core of the eurozone? If past events are anything to go by this is unlikely and could be the reason why the current situation has been more idiosyncratic in nature compared to the euro-sovereign crisis of 2011 when events in Greece spread across all sectors. Peripheral bonds (e.g. Spanish banks), were in focus during early morning trading yesterday, but the sell-off was contained as investors stepped in looking for assets at relatively attractive levels.
The market will be tested this morning by an Italian debt auction in 5yr BTPs (up to €1.75bn), 10yr BTPs (€2.25bn) and 7yr FRNs (€2bn) but, at the new enhanced levels, and with the ECB asset purchase programme still in place, we wouldn’t be surprised to see a reasonably successful auction; particularly as there has been c.€21bn of BTP redemptions and coupon payments over the past week.
In addition, this morning we have seen signs that the leaders of the Five-Star/League coalition have softened their stance to try and solve the stand-off. Rumours are emerging that Five Star and League officials are meeting with Mattarella this morning with Giancarlo Giorgetti (an experienced lawyer) being proposed as PM with Paolo Sovana taking a less prominent role. The Italians would still be a thorn in the side of the eurozone, but the irritation would be long and drawn out at the negotiating tables in Brussels, and markets would recover from the current heightened level of uncertainty.
This is a fluid scenario which we continue to watch with interest and, like the rest of the market we are in need of some greater clarity. That said, the wider fundamentals remain unscathed and the market technical remains supportive, as illustrated by buyers stepping in this morning looking to pick up assets at more attractive levels.