More geopolitical turmoil is probably not what the doctor ordered for markets on a day when Trump’s decision on the Iran deal is on deck, but you know what they say about “when it rains”.
As Barclays recently noted, the geopolitical environment “is littered with an historically large number – by one measure, the highest since World War II – of international conflicts with high potential to affect the global economy and markets.” And while Italy’s hopelessly fraught political situation doesn’t really qualify as an “international conflict”, it most assuredly qualifies as “conflicted” after an inconclusive election in March left the country without a government.
Of course thanks in part to ECB QE, having a government apparently isn’t a prerequisite for finding sponsorship for your debt. In fact, as of early April, periphery debt had become an “unlikely” safe haven at a time when the world was teetering on the edge of a trade war.
Here’s what the yield spread between the safest of safe havens (bunds) and Italian 10s looked like as of April 5 (note the steady grind tighter):
Of course as we reminded you at the time, BTPs have gotten more than a little support from a certain central banker who has pledged to everywhere and always do “whatever it takes” to make sure the periphery doesn’t lose market access like it nearly did during the European sovereign debt crisis.
Well fast forward a month and now it looks like new elections are coming in Italy. As Bloomberg writes, “Luigi Di Maio, head of the anti-establishment Five Star Movement, and Matteo Salvini, who leads a center-right alliance and the anti-immigrant League, are pressing for an election in July after efforts to form a government broke down [and] the populist rivals met in Rome Monday for the first time in since the March election following weeks of phone contacts.”
So there’s a bit more uncertainty for you (populists taking complete control) and Italian bonds are selling of bigly, with 10Y yields up some 10bps:
And the spread to Germany widening markedly from two weeks ago:
Italian stocks are down sharply:
“Snap elections are increasingly likely at this stage,” Barclays’ Fabio Fois wrote in a note on Monday, before identifying “two types of risks” that would arise under a snap vote:
1) From a political standpoint, we see the risk that Italy could appoint an anti-system government comprised of M5S and L. Without a reform of the voting system, electoral polls indicate that the current political impasse would likely be replicated. What could change, in our view, is the potential behaviour of political parties after the next elections, and in particular that of L.
2) From an economic standpoint, we see two main risks. First, extended political uncertainty could dent Italian business confidence, which would delay investment decisions. Second, there may not be enough time for the next government to deactivate 2019 fiscal clauses (VAT hikes of 2.2pp for the standard rate, to 24.2%, and 1.5pp for the intermediate rate, to 11.5%, worth c.EUR13bn). This would have immediate repercussions on the Italian economic outlook because it would hamper private consumption, the stronghold of the modest economic recovery which has unfolded so far.
Between renewed political risks in Italy and jitters over the Iran deal outcome, EURJPY is now in its longest losing streak since April of last year, down 10 days in a row:
And so, with the outlook already complicated by the Q1 deceleration in the European economic data, Mario Draghi and the ECB may now have to factor another bout of periphery spread widening into the equation when it comes to deciding whether to slap a September sell-by date on APP.
Good luck with that.