Italian Bond Yields Jump
Italian bond yields (Figures 1.1 & 1.2) have risen rather dramatically this week despite some political actions that should eventually lead to a favorable resolution for the European Union’s third largest economy, Italy.
• The IMF and EU Commission will adopt a stricter, more involved review of Italian fiscal measures.
• Prime Minister Berlusconi has pledged to resign after losing his majority.
• The removal of Berlusconi is a necessary component in order to give confidence a chance to reemerge.
• Currently absent is confidence in the ability of Italian government officials to navigate its budget away from a bond default.
When the Italian parliament provides comfort to the IMF and EU Commission – through its actions, not words – that the proper austerity measures will be enacted, and strictly adhered to, I expect the ECB, EFSF, and IMF to stand ready with wallets open. That favorable outcome, however, seems at least a few weeks away.
In the near term, global markets are focused on rising bond yields as financial institutions sell their holdings of Italian paper. The London Clearing House (LCH) raised initial margins on Italian collateral with further margin raises expected as the spread between Italian and German paper continues to widen beyond the 450-basis point threshold. In essence, financial institutions have been presented with a margin call this week.
The market has been incredibly resilient in the early days of November, shaking off any bad news and maintaining the large gains from October. However, the uncomfortable rise in Italian bond yields is a headwind that will challenge global markets from extending October’s gain, and raising the ceiling beyond 1300-1325 in the S&P 500® Index (Figure 1.3).
Figure 1.1 Italian 5-year Government Bond Yield
Figure 1.2 Italian 10-year Government Bond Yield
Figure 1.3 S&P 500 Index, July to November