- European markets hit hard by the Italian political deadlock
- Better-than-expected US data and Bernanke testimony arguing against an early exit from QE supports sentiment in the US session
The European session yesterday was not surprisingly focused on the uncertain political situation in Italy and the result was a true risk-off day. Italian equities sky-dived close to 5% but the German DAX was also hit hard dropping 2.3%. But the closest watched market yesterday was of course the Italian government bond market which saw a significant sell-off and huge volatility and Italian 10Y government bonds underperformed by close to 50bp against Germany. Other peripheral countries were also hit hard with Spain losing 30bp and Portugal losing 45bp against Germany in the 10Y segment.
The election results means that we could face months of uncertainty in Italy and yesterday did not bring much clarity. The centre-left leader Bersani said he would try to form a minority government and he called on all his opponents to support his five-point programme that talks about easing austerity and job promotion. The response from the Berlusconi centre-right coalition has been ‘frosty’ but it seems clear that neither Berlusconi not Bersani is interested in a new election. If there is one thing they seem to agree on is that going back to the election booth would risk an outright victory to the Five Star Movement led by comedian Grillo. If we see more progress towards a so-called grand coalition it might help to stabilise the current nervousness in the peripheral bond market. The first test might very well come today when Italy once again auction bonds. Note that Moody’s this morning said that the inconclusive election result puts Italy’s rating at risk of a downgrade.
Despite the uncertain situation in Italy, Wall Street ended the day on a positive note with the Dow Jones Index having one of it best days this year up 0.8%. The US market really already took a beating on the Italian news on Monday. But the positive development was also helped by a bunch of positive economic US data showing that the US recovery is still on track. New home sales surged by 15.6% and house prices rose by 0.6% in January, consumer confidence jumped much more than expected and the Michigan Fed Survey recovered in February. Overall data suggests the underlying fundamentals continue to improve.
Sentiment was also supported by the Bernanke testimony. Bernanke once again eagerly defended the Fed’s QE programme and quieted the discussion of fear that the Fed would scale back its open-ended easing in the wake of the improving data. Bernanke downplayed the costs of QE, suggesting that they will not prompt and early ‘exit’. He also underlined that high unemployment has substantial costs. However, he did indicate that the bar for more easing is relatively high, saying that more QE may erode confidence in the Fed’s exit ability .
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