MacroScope

Italian political curveball

December 10, 2012

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Italy’s borrowing costs over ten years drew closer to five percent after a decision by Prime Minister Mario Monti to step down early left the country’s political future unclear, hurting riskier euro zone debt.

Monti said on Saturday he would resign once the 2013 budget was approved, raising questions over who will take the reins of the euro zone’s third largest economy at a time when it remains a focus of the region’s three-year debt crisis.

His announcement, potentially bringing forward an election due early next year, came after former prime minister Silvio Berlusconi’s party withdrew its support for the government — and Berlusconi himself said he would run to become premier for a fifth time.

Justin Knight, European rates strategist at UBS says:

Berlusconi’s actions have created a degree of uncertainty in the market with regards to the Italian political scene. Part of the problem here is that investors outside of Italy are not positioned very well for this.

He was referring to the recent bout of buying in Italian debt, mainly thanks to the European Central Bank’s promise that it will provide central bank support – should a country decide to ask for aid first.

Such pledges have been enough to drive Spanish and Italian borrowing costs some 200 basis points lower since July. The extent of the recent rally and the fact that liquidity is thinning into the end of the year could exacerbate any market sell-off, analysts said.

Ten-year  Italian yields jumped 29 basis points on Monday to 4.83 percent, and Spanish yields followed suit with a 13 bps rise to 5.61 percent.

Uncertainty regarding the make-up of Italy’s next government and its commitment to austerity were behind the rise in yields rather than the prospect of Berlusconi’s return to power, given opinion polls give him little chance of success, some said.

According to one trader: “Any question over their dedication to austerity is not going to be good for BTPs (Italian debt), especially given the  fact that everyone is long.”

UBS’s Knight, however, was mostly concerned about the unfortunate timing of the rise in political tension –  just as investors have ventured back into Italy.

According to Knight:

They’re quite close to neutral versus benchmarks, having previously been underweight of both Spain and Italy. Some investors are now overweight, and we have seen more investors going overweight over the last few weeks.

Adding insult to injury, the sovereign sells three-year paper on Thursday. The results could be decisive for market sentiment.

Marc Ostwald, strategist at Monument Securities says:

I don’t think the market is really going to take Italy to task, unless they struggle with the BTP auction this week, which I don’t think they will.

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