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Risk-Off as Italy Rocks Markets

 

What is Going on in Italy?

In its most basic form, what is evolving in Italy is a political battle between the anti-establishment populist parties (Five Star Movement, League party) and the pro-EU incumbent administration.  The genesis for the heightened political turmoil in the euro zone’s third-largest economy traces back to March of this year, when the Italian general election produced a hung parliament, leaving no party with a majority.  Since that time, populist parties have spent weeks of negotiations to form a coalition government before announcing their combined nomination for economy minister, Paolo Savona, this past weekend.  As a former banker and economist, Savona was viewed as too much of a hyper euroskeptic (as per the current Italian regime) who posed too much of a risk to the Italian economy and was blocked by President Sergio Mattarella as a result.  Mattarella then went on to appoint former IMF official Carlo Cottarelli (pro-EU) as caretaker leader, who is expected to only be a short term solution and lead to calls for a fresh round of elections as early as this August.  From there, the future of both Italy and the EU as a whole remains in jeopardy. 

 

 

Risk Off on “Existential Crisis” for EU

With Italy threatening to leave the European Union, in what George Soros dubbed an “existential crisis” for the European Union, there was a flight to quality assets today which generated a big move across various asset classes.  Equity markets felt the heat, with all three major indices down on the day, as the DJIA sunk 1.58%, followed by the S&P falling 1.16% and the NASDAQ dropping 0.5%.  Flows moved into the quality assets with Treasuries rallying throughout the day. Yields/swap rates gapped 10-19bps lower across the curve, with the 10 year closing at a yield of 2.78% (-15bps).  In foreign exchange markets, the US Dollar (USD) benefited as result of the political uncertainty in Europe, gaining 0.8% vs the Euro (EUR) and 0.5% vs the Pound (GBP).  As the dollar gained, crude oil futures fell 1.6% to $66.82/barrel alongside the continued specter of increased production from Russia and Saudi Arabia.  

 

 

Bullard Comments on US Rates

St. Louis Fed president James Bullard (current non-voter, will be a voting member in 2019) told reporters “It is hard for U.S. rates to get too far out of line with the global rate situation, and obviously both the (Bank of Japan) and the (European Central Bank) are continuing very accommodative policies,” after a speech in Tokyo.  During the speech Bullard expressed the need for caution in raising rates too aggressively, citing his concern for an inverted yield curve due to increasing front end rates too quickly and noting that the curve could invert “later this year or in 2019”.  Furthermore, as Bullard sees low inflation expectations, he expressed caution in the approach  “A reasonable policy going forward may be to temper the pace of normalization in order to re-center inflation expectations at the Committee’s 2 percent target”.  Commenting on longer term rates, Bullard said that rates may have already reached their neutral level, noting “the nominal policy rate set by the FOMC is already pressing against the upper bound of a neutral setting”.

 

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