Overnight Sentiment Unhappy As Europe Is Broken Again: Italian Yields Soar

While the market will do everything in its power to forget yesterday's Hung Parliament outcome ever happened, and merrily look forward to today's Bernanke testimony (first of two) before the Senate, Europe is not quite so forgiving. Because moments after today's Italian Bill auction in which the now government-less country sold €8.75 billion in 6 month bills at a yield of 1.237% nearly double the 0.731% yield for the same issue previously, things went bump in the night, leading Italian 2Y yields to surge +38bps to 2.086%, vs 2.063% earlier, while the benchmark Italian 10Y yields soared +28bps to 4.766%, vs 4.739% earlier, and just shy of JPM's 5% target. Spain is not immune from the Italian developments, and while it will take the market some time to realize that the next political scandal may be dropping this time in Spain (as reported yesterday), the Spanish 10 Year is already up 7% to 5.23%. Suddenly talk of parity between Italy and Spain may be on the table all over again. And while unlike yesterday there is US macro data, in the form of US consumer confidence, new homes sales and house price data, all the market will care about is soothing Wall Street sellside spin that Italy is not really as bad as everyone said it would be if precisely what happened, happened. With the EURUSD on the verge of breaking down the 1.3000 support, it is very unclear if they will succeed.

And just in case they fail, the French Industry Minister Montebourg, made infamous from his Titan CEO series of letters, already has a solution - the same solution to everything - as he says the ECB should monetize debt. His goal - to lower the EURUSD.

France's industry minister Tuesday called for a lower euro and said the European Central Bank's role should be reinterpreted, wading back into a currency debate that had been calmed by an agreement between the world's top finance ministers earlier in the month to refrain from competitive devaluations of their currencies.


"I am for a less-strong euro," Arnaud Montebourg said at a meeting with journalists in Paris, adding that it is "good news" the euro has recently declined against other currencies.


The single currency has fallen around 4.6% against the U.S. dollar since the beginning of February.


"I am very happy, [the decline] should continue," Mr. Montebourg added.


Still, the industry minister also said Tuesday the role of the European Central Bank should be reinterpreted. The Frankfurt based institution's primary mandate is to fight inflation, but Mr. Montebourg said that within the current European treaties the ECB can be more pragmatic and less dogmatic. It should act more like other major central banks, which Mr. Montebourg said had monetized debt.

Luckily the world has no currency wars to worry about, or at least the Italian elections pushed them off the front-burner.

What else? from Bloomberg:

  • Treasuries gain for a second day, with 10Y yields breaking below 50-DMA, 5Y and 7Y yields declining to just above 100-DMAs following inconclusive Italian elections.
  • Bernanke delivers semiannual testimony on monetary policy to Senate Banking Committee; his efforts to rescue economy could result in more than a half trillion dollars of paper losses on the central bank’s books if interest rates rise abruptly from recent levels
  • EUR/USD at 1.3097 after yesterday’s 1.1% decline to as low as 1.3048; Italian stocks slide 4.5%, bond yields surge as Italian party chiefs began jockeying to forge a coalition of rivals, head off a second vote; Bersani and Berlusconi may be seeking to avoid a ballet that would favor populist  Beppe Grillo
  • Japan’s government bond yield curve is pricing in the success of Haruhiko Kuroda in adopting more aggressive easing as the next Bank of Japan governor and his ultimate failure to hit a 2% inflation target
  • There isn’t a measure of money in the U.S. that is forecasting worse times ahead as lawmakers voice alarm that the automatic spending cuts  scheduled to begin March 1 may damage the economy
  • BofE Deputy Governor Paul Tucker said he’s open to adding to asset purchases, suggesting Governor Mervyn King’s defeated push for more stimulus is gaining traction with his colleagues
  • Week’s auctions continue today $35b 5Y, yield 0.768%, WI trading yields 0.788%. Yesterday’s 2Y drew 0.257%, just below 0.26% WI level
  • Nikkei falls 2.3%; European stocks slide,  U.S. equity-index futures gain. German, U.K. bonds rise. Energy, precious metals lower

Quick market recap:

  • Spanish 10-yr yield up 7bps to 5.23%
  • Italian 10-yr yield up 29bps to 4.78%
  • U.K. 10-yr yield down 7bps to 2.01%
  • German 10-yr yield down 8bps to 1.47%
  • Bund future up 0.86% to 144.75
  • BTP future down 2.98% to 109.17
  • EUR/USD up 0.16% to $1.3084
  • Dollar Index up 0.11% to 81.76
  • Sterling spot down 0.17% to 1.5137
  • 1-yr euro cross currency basis swap down 1bps to -24bps
  • Stoxx 600 down 1.2% to 284.94

And the comprehsnsive overnight summary from JPM's Jim Reid

As of now the centre-left coalition led by Bersani is set to take control of Italy’s lower house, taking advantage of the majority premium where 54% of seats are allocated to the winning coalition regardless of the victory margin. The Bersani coalition took 29.6% of the vote, enjoying the slimmest margins of victory against the Berlusconi coalition (29.2%). The Five Star Movement came in third with a fairly stunning 25.6% of the votes. The Monti coalition trailed a distant 4th with 10.6% (Bloomberg, citing Interior Ministry data)

Meanwhile in the Senate, it is becoming a near certainty that no grouping will gain a majority. As it stands, with close to 100% of the vote counted, Bersani’s coalition (31.6%) leads Berlusconi (30.7%), the Five Star Movement (23.8%) and Monti’s coalition (9.14%).

Indeed one of the stand-out features of the poll is that Mr Monti polled at only around 10% nationally. It’s fair to say that his policies/views would have been supported by virtually all the main EU players, including the ECB. Yet only one in ten Italians are prepared to back him. Since the ECB stepped up a gear last year, politics was always going to be the key issue for whether they could truly rescue Europe. The voters have certainly made it clear that they are not prepared to accept the combination of austerity and negative growth that the EU's policies have encouraged. Either Europe needs to change its bias or the voters will cause major issues going forward.

Late on Monday politicians were already calling for another poll to break the deadlock, while others expressed the fear that the Five Star Movement would only gain in strength if another election was called which might prompt Bersani to try to form a Government somehow. Angelino Alfano, the People of Liberty secretary, said that the lower house result was within the “margin of error” and demanded a review of the results (FT). According to newswires, should new elections be necessary it is possible that the Italian President could appoint a caretaker PM to change the electoral law to increase the likelihood of a definitive result in a new election, but it is worth noting that the parties were unable to agree modifications in the electoral law last year. Overall it now looks like we will get our “risk-off” February we've been expecting due to the Italian elections but our view of a “risk back on” March now looks threatened by the prospects of a stalemate and weeks of uncertainty in Italy.

Across the Channel, there was some respite for sterling after the UK's downgrade with it gaining 2.5% against the euro from the intraday lows yesterday helped by the risk aversion late in the European session. The pound closed with a gain of 0.97% and is adding a further 0.3% in Asian trading.

10yr Gilts also rallied by 8.5bp from the day’s highs to close at 2.08% yesterday, a lower level than where they last trading before the Moody’s downgrade on Friday.

The risk-off trade prompted an aggressive day of buying in US Treasuries. The 10-year UST yield fell 14bps from the intraday highs to close near its lows of 1.864%. This is perhaps also a reflection of market positioning given the much debated topic of the Great Rotation trade lately. The VIX index erased all of its 2013 move with a sharp spike overnight (+35%) while in credit the CDX IG widened 4bps and we are back to roughly where we were at the start of the month.

Asian markets are following the US lead lower overnight with the Nikkei (-2.3%) taking the lead on a JPY rebound (the yen rallied 1.7% yesterday). The Japanese government is expected to present to the Diet its candidates for the BoJ governor and two deputy governors on Thursday or Friday of this week according to the Nikkei.com. Elsewhere the Hang Seng and KOSPI are -0.89% and -0.47% lower respectively. There are some overnight reports of near-term Chinese macro tightening which is not helping sentiment overnight (China Securities Journal). However Chinese equities are managing to buck the regional trend by erasing earlier losses to trade relatively flat on the day. The weaker overall tone has also brought about more balanced flows in Asian credit although the key indices are still 2-3bp wider on the day.

Bernanke’s semi-annual testimony to the Congress will be a key event today. The Chairman will testify ahead of the Senate Banking Committee today (3pm London) before doing the same before the House Financial Services Committee tomorrow. Our US economists are not expecting the Chairman to express a meaningful change in viewpoint at this juncture due to lingering uncertainty about the economic outlook but given the increasing focus  around the ‘tapering’ of QE, his words will be closely followed. On that note it’s perhaps worth highlighting a WSJ article by Jon Hilsenrath yesterday who concluded that the fact that Fed officials are talking about tapering and exit doesn’t mean that they are about to turn off the spigot. Many officials still want to keep the Fed’s pedal pressed on the floor – an analogy used by Fed’s Yellen recently. Note that our Peter Hooper thinks that assuming the recent firmness of payroll growth continues he expects the Fed to downshift and eventually end its asset purchases during 2H of this year.

Outside of the Italian elections and Bernanke's testimony, we also have US consumer confidence, new homes sales and house price data to look forward to today. The US treasury will also auction $35bn in 5yr notes. But in reality, this will all be a sideshow to the developments unfolding in Italy and Washington.


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