The Italian Job

Marc To Market's picture

The foreign exchange market has calmed after initial follow through to the dramatic price action in the North American afternoon yesterday as it became clear that the Italian election was not going to produce a majority in the Senate. 

While several large countries, like the US, Germany and Japan, have divided houses as it were.  The problem in Italy is no party has a majority.  And with the poor showing for Monti and the exceptionally strong showing of Grillo's 5-Star Movement means that the much heralded center and center-left coalition is insufficient to secure a majority.

The situation needless to say is very fluid and although the euro has stabilized, the threat to euro area stability is clearly evident in the debt markets where Italy's 10-year yields has soared 32 bp and the spread over Germany has widened by more than 40 bp.  Other peripheral bond markets are also under pressure as are the credit defaults.  Equity markets are also taking it on the chin.  Italy's bourse has been crushed, losing more than 4.5% and dragging down the other markets as well.  As one would expect, the financials sector in Europe is the hardest hit, underscoring that the link between sovereigns and the banks remains tight.

There are broad and narrow implications of the election.  Some will see the majority vote for the parties that want to leave EMU as the beginning of the end, sparking a new phase of the financial crisis.  Austerity has so weakened the social fabric that it has eroded the political center.  A political crisis is more immune to ECB action and the OMT than a private capital strike.  However, it may be jumping hastily to a conclusion that all who voted for the center-right and Grillo did so to express a desire to leave EMU.  There were many reasons why the voters would want to express disapproval of the technocrat government that promised better days but failed to deliver growth or jobs.

The narrower interpretation would suggest that while there will likely be much posturing in the coming days, a center-right and center-left coalition on a fixed and limited program that would include the naming of a new president (current terms expires mid-April), perhaps some limited stimulus, and electoral reform that sets up for new elections in a few months.  Perhaps this is too much to envision immediately and the Italian politicians may have to try the other alternatives before choosing the most sensible. 

The 5-Star Movement, is the largest single political party in Italy and yet the anti-political stance makes governing impossible.  Grillo is quoted in the media saying "No deals.  Its a War.  To those who are susceptible for confusing metaphors for reality (see currency war), Grillo is declaring a political war against the political elite, but that same strident stance may make him irrelevant to forming a coalition. 

Italian developments are overshadowing other important developments.  In Japan, it is looking increasingly likely that Asian Development Bank head and former MOF Kuroda will be the next BOJ Governor. The naming of the BOJ team is the last piece to fall in place, we suspect, before investors give Abenomics its real test.  The violent recovery of the yen over the past 24 hours is not driven by Japanese developments of course but the unwinding of the risk-one trade due to European developments.  The yen's recovery took the shine of Japanese shares and the Nikkei tumbled 2.25%.

If the purpose of QE is to drive down interest rates and more aggressive asset purchases will be seen under the new BOJ regime, how much lower can yields be driven in Japan?  What is ultimately desired are structural reforms the increase capacity of the economy--not through fiscal spending, but, for example, broadening the labor force participation and opening up more parts of the economy to competition.  

In the US, the first leg of Federal Reserve Chairman Bernanke's semi-annual testimony is the main feature.  We think many observers read the recent FOMC minutes in a way that gave too much emphasis to non-voting regional presidents and not enough to the Board of Governors, and especially, the Fed's leadership.  Bernanke is likely to reaffirm the accommodative stance and, with European tensions flaring, can point to external risks as well as domestic.  The sequester, which includes $85 bln in new spending cuts for the remainder of the fiscal year,  also part of the domestic headwinds that the economy faces.

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Meremortal's picture

I am descended from the Samnites, a trible that held sway in central Italy for centuries. The Samnites were never conquered by the Romans, who simply worked around the tribe and kept relations as civil as possible. There are many such social divisions in Italy, despite the fact that 92% of all Italians are related by blood.

Italians have never been governable, the situation is old, not new. 

In Italy, as in the rest of the developed world, the search for a painless way out of fiscal insolvency continues. There is no such solution, so delay and pretend is still in sway. 

Germany is the only country left holding the Eurozone together. Doing so going forward will require Germany to part with about 10% of its GDP annually. It is handing out 5% now. Will it do 10%, and for how long?

No one knows. A year, a decade, longer?

The leaders are in for the duration, the voters may take a different view at some point.

When Germany becomes "ungovernable", watch out.




Jack Sheet's picture

The more parties the better. Just take a look at the Republocrat/Wall Street/Bankster united fascist front to quiver at the alternative. Thank God Germany has 4-5 parties  capable of getting seats in regional and national parliaments.

Dead Canary's picture

Beppe Grillo! You da MAN!

falak pema's picture

The termites start coming out of the woodwork; or the rats start leaving the ship!




La prochaine crise bancaire viendra du système parallèle ?

When thieves fall out and start protecting their asses; read : the Beppe Grillo tsunami effect on world banking! 

Orly's picture

But wait!  They said they are going to try to regulate it!

Whew.  I feel better already.


Edward Fiatski's picture

Oooh, Bernanke speaks today - BTFD.

Good article, Marc -- We hit 200 DMA on the EUR ytd like a charm, and there's a very major fib running at current levels as support.

Wednesday & Thursday should be interesting. :)

Fuh Querada's picture

Can you provide a validation of the 200 day moving average as a trend indicator beyond the circular explanation that many market participants believe in it ?


Edward Fiatski's picture

The answer is always 42, little cow.

Orly's picture

...especially when all of human nature revolves around the number twenty-eight?

Orly's picture

We are, basically, products of the ocean.  We crawled out from there way back in the day.  Just because we can read a book doesn't mean we are not governed by where we came from.

The oceans are ruled by the Moon, which has a twenty-eight day cycle of waxing and waning, influencing high and low tides in the very waters of our origin.

A woman's cycle is also twenty-eight days because she ebbs and flows as the Moon and the tide.

To say that 4X traders are not influenced by that is not possible to believe.  Mathematical proof of natural patterns and cycles were brought to the Western world by Fibonacci in Pisa and showed us that, despite our education and desire to be godlike, we are still animals of the Earth and are guided and driven by Nature.

The 200 and 50 SMA simply makes no sense at all in Nature.  They are pretty much random numbers.


Edward Fiatski's picture

YEAH! Fuck 50DMA, I'm slappin' a 69 on my charts from now on.

Orly's picture

Fifty-six and two-eighty, if you must.  But moving averages don't tell you anything anyway, except where stuff was a long time ago.

You're much better off using Fibonacci levels and a zigzag with harmonics.  That tells you where you are now.


Oh, in re: to zigzag, change the candle depth to one-half of twenty-eight (up plus down...), or fourteen.  You'll be surprised.  I know I was.


Edward Fiatski's picture

I never use any of that high tech stuff mumbo-jumbo - a candle with a mirror in a dark room is the best method, followed by dried coffee beans roulette.

bank guy in Brussels's picture

From the article above, quoting Beppe Grillo:

« No deals. It's a War ! »

Yes it is. The right attitude !

Ghordius's picture

it's puerile. they got some quarter of the votes but are not interested in taking part of any government - nothing new under the Italian sun

Dead Canary's picture

The governmemt is rotten. I say they stick to their guns and boot out the status quo.

Oldwood's picture

Anyone who resists the inevitable is an obstructionist. Anyone who wants things to be like they were even ten years ago is an extremist and those who want to go back two thousand years are progressives. How could things possibly go wrong?