Euro accelerates lower on Italy

Euro accelerates lower on Italy

Summary

Market relief following the implosion of Italy’s would-be coalition government has given way to further risk aversion, as the euro will be at the heart of fresh elections likely to be held within months.

Spreads lord it over markets

European shares stayed sharply in the red by late morning on Tuesday and U.S. indices were setting up for a negative start in the wake of dips by large Asia-Pacific equity gauges. EUR/USD continued to be pressured by the spread between benchmark bund yields and Italy’s 10-year BTPs widening the most in 4½ years. The euro against the dollar last traded at $1.1544 as short covering propelled the rate some 40 pips up from lows marked earlier and last seen in July last year. Euro weakness was also drawing the yen up to an almost one-year higher against the single currency, partly on a deepening search for safety. All in all, it was evident that risk aversion stemming from Italian, and in turn European markets, was echoing more widely.

Yen, U.S. Treasurys strengthen

Treasury yield elevation of the last several weeks was replaced by demand for U.S. benchmark debt as per Germany’s 10-year bund. The yield on the latter had broken below 20 basis points for the first time since April, whilst Italy’s ten-year yield surged as much as 700 basis points to the highest since August 2014. Against this backdrop renewed dollar strength was less a function of increasing U.S. inflation expectations than a mirror image of euro lows— the dollar index was up almost 700 ticks, yet the greenback was 50 pips lower against the yen and the 10-year Treasury yield was below the 2.8% handle for the first time in seven weeks.

New PM attempts the impossible

Clearly, the Italian political drama will be the key feature of investor attention on Tuesday and for weeks to come. Carlo Cottarelli, appointed as interim PM by increasingly focal head of state Sergio Mattarella, is widely expected to fail to form a government. The chances of this being pulled off did indeed look grim considering the combative reaction from 5-Star and the Northern League leaders immediately after PM designate Giuseppe Conte gave up his own attempt. The 5-Star/League combination was possibly one of the few political entities likely to survive the stalled proceedings, but even there the outlook was hazy. For one thing, League leader Matteo Salvini on Monday slapped down a call by his 5-Star counterpart Luigi Di Maio for President Mattarella to be impeached. And neither sides had not been averse to anonymous press briefings over the last few weeks critical of the other’s policies on which they differ. Cottarelli said he foresaw elections in the autumn whilst noting Italy’s economy was in fact in a growth phase with public accounts under control. It looks like the market needs convincing that the path towards fresh elections won’t be a politically disorderly one.