Italy - Uncertainty

This morning, Bloomberg reported that global markets went into panic mode, with investors shunning securities of euro-area peripheral economies and fleeing to the safety of U.S. Treasuries and U.K. gilts. Euro-area bond markets were rocked by poor liquidity, with limited quotes available for parts of the Spanish bond market and most of Italy, hinting at an “unwillingness” to trade.

The yield on the Italian 2-year bonds were up 169 basis points to 2.59 percent as of 10:42 a.m. in London, having touched 2.83 percent, the highest level since 2012. The rate on 10-year notes rose 56 basis points to 3.31 percent, the highest level in more than four years after markets got knowledge that the two coalition populist parties had begun mobilizing for an early election.

U.S. 10-year yields fell as much as 13 basis points to 2.80 percent, the lowest level since April 12, while comparable yields on U.K. gilts tumbled 12 basis points to 1.20 percent.

On Sunday Italy’s president explained the reasoning behind the rejection of the failed anti-party coalition’s proposed finance minister because of his support for a plan to leave the euro.

For investors it could worth recalling that during the 20th century all monetary unions have ended in a breakup and the sole exception to that has been the U.S. monetary union breakup in 1933 that was reversed after the Emergency Banking Act was passed, which allowed the government to establish 100 percent guarantees for bank deposits and gave the Federal Reserve banks the power to issue additional currency to meet every legitimate call, as President Roosevelt put it.

For now, an Italian technocrat government is being formed. In the event that this government is rejected by Parliament, new elections will have to be called.

Aside from anything else, fears for a monetary union breakup would be visible in bank deposit flight far more than in bond market moves.

Spain meanwhile is having a no-confidence vote on Friday. Spain’s benchmark yields rose as much as 22 basis points to 1.74 percent.

Today, there are few ECB speakers on the schedule today, and this political noise may be of relevance to their remarks. We’ll see if we learn something new.

Ordinarily, politics can safely be ignored by central bankers as politics does little to affect the short-term economic cycle.

However, with Italy we have problem because the fiscal proposals of the Italian “anti” parties is such that these, if applied, will have a serious economic bearing.

Of course, we aren’t there yet.

Anyway, German Chancellor Merkel gave yesterday voice to some strong opinions suggesting the rise of anti-parties in Europe was not an example of a failure of political leadership, it was all the fault of bankers.

Oil Prices

Meanwhile, oil prices have continued to weaken albeit in thin trading conditions as traders review the likely production response of countries like Saudi Arabia. The level of oil prices is still sufficiently high that economic analysis of this should focus on high oil prices, not falling oil prices.

As headline and core inflation rates rise, there is a transfer of spending power away from oil consumers towards oil producers and the demand for dollars is higher than it was 2 months ago as more dollars are needed to pay for the same barrel of oil.

However, if the oil price continues to decline, then this narrative will have to be softened or possibly be reversed.

We’ll see if Russian President Putin will stay with what he said a couple of days ago: “Oil prices at $60 a barrel fully suits Russia and the country doesn’t want them to spiral higher.”

Emerging Markets - Turkey

Turkey, an emerging market country that has the benefit of having its own currency and its own interest rate setting central bank saw its central bank raise rates yesterday. The overnight repo more than doubled. Alongside this there is a promise to “simplify” the extraordinarily complex process of setting interest rates in Turkey. After the adjustment, the benchmark rate will be 16.5 percent, unchanged from the current main funding rate.

The Turkish lira has rallied swiftly and is now trading at the level it was… last Wednesday.

Economically, what Turkey needs is a policy that will create stable growth with a manageable current account deficit. Attracting short-term capital flows is not enough in Turkey’s case. The signals around the reform of the central bank’s policy rate structure will therefore be particularly important.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.