European markets brace for week ahead

European bonds and equity markets scattered on Friday as a new Spanish political drama joined the one in Italy, giving markets a taste of likely gyrations next week.

European markets brace for week ahead

Summary

European bonds and equity markets scattered on Friday as a new Spanish political drama joined the one in Italy, giving markets a taste of likely gyrations next week.

Et tu Spagna?

Those searching for specific triggers of resurgent Italian market risk aversion could point to reports of meetings by PM-designate Giuseppe Conte with key political and monetary officials. He was preparing to present his cabinet to the country’s administrative president, Sergio Mattarella, a meeting ongoing at the time of writing. Renewed capital markets mayhem also reflected position-squaring ahead of a holiday in the United States and the UK. Many participants decided against keeping trades open amid potentially unpredictable weekend events. The effect of declining liquidity was another factor. Brewing political discontent in Spain bubbled over on Friday to give sovereign yields wings there too. Spain’s main opposition party tabled a confidence vote against PM Mariano Rajoy. The third largest party said it could support a similar motion if Rajoy didn’t call early elections.

Bond crisis mini-redux

Spain’s IBEX 35 stock index tumbled at the same 2% rate as Italy’s FTSE MIB at their worst, and both closed around a percentage point and a half lower, easily the worst performance amongst large European markets. Even Germany’s DAX, driven higher by rebounding car stocks, erased all of its 120-point plus gain at one point in a flash of panic, before recouping. For the first time since Italy’s referendum, European political uncertainty provided the region’s bonds sufficient momentum to begin leading U.S. Treasurys. It was notable that the U.S.’s 10-year benchmark yield notched three-week lows almost simultaneously as flows into the perceived safe-haven of Germany’s bunds drew those yields below 40 basis points for the first time since late December.

Euro close key

With equity and bond market participants fading away at the time of writing, euro trading was the last important remaining arena for reaction to Conte meeting Mattarella. The single currency was at its lowest since November at $1.1644, offering similarly beleaguered sterling its only avenue of thin gains against a ‘major’. The euro’s close on Friday will offer clues about how Italian and Spanish bond markets begin the week ahead. It was also notable that the sharpest attacks on Italian paper were at the short – and most volatile – end of the yield curve, widening the gap between German and Italian two-year bonds to the widest since November 2013, whilst 10-year Italian BTPs yielded 2.55% for the first time in just over a year.

A very short squeeze possible

For shorter-dated debt in particular, elevation had reached such an extent that it was crying out for a squeeze of bond speculators, or simply profit taking. That would bring a rapid unravelling of fever-pitch levels in the near term. The euro against the dollar suggested a similar structure after more than a month in which almost every session brought a further decline. With Italian politics in flux though, any such bounce would have a high probability of being short-lived. Reduced liquidity with London and New York away could then fuel further volatility and fresh forays on the downside for bonds, stocks and the euro. A sustained spate of fresh lower milestones in these asset classes is likely once post-holiday volumes return on Tuesday.


Join our live webinars for the latest analysis and trading ideas. Register now

GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.