Less complacent
European markets dropped their air of complacency after Eurosceptic parties outshone the establishment in Italy's general election, igniting volatility in Italian bonds. A final vote tally was still some hours away, but it was already clear the anti-establishment 5-Star movement won more votes than any single party and that anti-immigration Lega Nord eclipsed Silvio Berlusconi's Forza Italia, to become the dominant party in their grand coalition. Single currency market action has been choppy since late Sunday, whilst the yield on Italy’s 10-Year BTP benchmark bonds swung 10 sharply wider—by 10 basis points—compared to Europe’s benchmark, 10-year Bunds. Still, investors were less relaxed rather than outright perturbed. Volatility implied by the cost of euro options prices eased in short and long-term trades, suggesting falling demand for protection of large cash positions.
German politics slot back into phase
A two-third majority vote by members of the Germany’s SPD to continue the long-standing grand coalition with Chancellor Angela Merkel’s CDU took some of the edge off the unsettling outcome in Italy. The six-month stalemate with tortuous and uncertain negotiations had fed investor wariness that at worst, another election might be required. Instead, a larger than expected SPD vote in favour paves the way for the drive towards a more transnational Europe, primarily sponsored by France’s Emmanuel Macron, to inch forward. That offsets vexed calculations over the extent of harm to markets from a possible anti-euro government in Italy.
Market eyes 5-Star’s rise
Whilst we expect Friday’s Italian stock and bond gyrations to fade within a week, the mathematics around the formation of a new government will keep investors unsettled for the medium term. 5-Star’s probable 32% vote share will best expectations that Luigi Di Maio’s party would scrape in below 30%. Together with Lega Nord’s new status as the leading party in the centre-right coalition, this will keep assets in the region out of favour; probably for months. A steady albeit orderly retreat of large Italian shares is probably on the cards. At last check the FTSE MIB traded 0.5% lower, improving on earlier losses of around 1.5%. Banks—particularly UBI Banca—remained amongst the worst hit, though with the main Italian bank index off by 1.5%, these too had more than halved early-session declines.
Mediaset bears the brunt
Only shares in Silvio Berlusconi-controlled Mediaset weakened further from previous falls, trading around 7% lower. It reflected disappointment that the former prime minster won’t be able to pull-off previous policy moves that coincidentally favoured large broadcasters. Wider European market impact was contained, helped by resolution of Germany’s stalemate. The DAX index there rose 0.8%. Markets in France, Spain and Portugal were slightly higher. Similarly, it was difficult to read any impact at all from Italy in S&P and Dow futures that were slightly on the back foot and Nasdaq contracts that had ticked into the black.
Bigger fish to fry
Attention was rapidly shifting to the week’s busy macroeconomic slate including Thursday’s ECB decision and Friday’s U.S. monthly employment data. The ECB will do nothing concrete, but attention on commentary will be rapt, as investors remain alert for policy signals. After months of expectations that key words around QE extension or expansion would be dropped from the ECB’s statement, probabilities have lately been disrupted. Unsourced comments have suggested the central bank has growing doubts. Updated ECB economic forecasts won’t be the story so much, though they’re likely to reflect steadily improving conditions and an underpinned euro. Later on Monday, the U.S. Institute for Supply Management’s services sector gauges will be in the spotlight. Attention will be on any hints to be gleaned about non-manufacturing employment, ahead of Friday’s payrolls. As for the latter, the key tally is forecast at 200,000, skimming along at the long-term run rate. But it will be the strength of wage growth and the implied read for inflation that could get the market most exercised. A monthly average earnings take that ticks down to 0.2% from 0.3%, as expected, would go a long way to cooling hotter than previously foreseen inflation expectations. In turn, an easier wage reading would reduce the risk of a theoretical fourth Fed rate hike this year, one more than the central bank has pencilled in. The reckoning that inflation was running faster than the Fed was prepared for was at the root of an upsurge in market volatility in recent weeks.
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