Italy cracks market calm

Summary

Investors scramble to cash in gains after reports that a Eurosceptic could run a senate committee in Italy.

Another Eurosceptic professor

Cautious advances by European markets are evaporating. Italy’s FTSE MIB is central in draining sentiment and last stood down 1.4%, deeper in the red than other major continental gauges. Italian stocks – particularly banks – reversed immediately after news reports that Alberto Bagnai, a professor at a university on the Adriatic coast, was made the head of a senate finance committee. Bagnai’s views place him firmly at the Eurosceptic end of the spectrum. “Undoing the euro will be costly”, he wrote last year. “Though less costly than its alternative which is protracted stagnation of the European and hence the world economy, and the growing risk of a major financial collapse”.

Volatility bounce

The market’s volatile reaction partly reflects persisting wariness about the 5-Star/Northern League coalition, despite its recent words and actions downplaying anti-EU and anti-euro views. Bond auctions in Spain held almost simultaneously with the news may also have played a part in thinning liquidity and creating price gaps. Some European markets were returning to gains at the time of writing. The pull back—which saw Italy’s 10-year yields spike over 160 basis points—could turn out to be an overreaction. As further details become known about how much influence Bagnai’s role may carry, the episode may look like a flash in the pan. However, it does underscore that the market’s apparent calm could be deceptive. CBOE’s VIX volatility gauge has turned positive in step with a downturn by U.S. index futures.

Green to red

Red has now almost entirely washed out the earlier perfect green across Wall Street futures and Europe. Only the FTSE 100 is keeping a toehold in the positive as new multi-month sterling lows underpin key exporter shares. Daimler’s decision to detail the worst-case scenario from potential auto sector tariffs made the share an early leader on the downside. Its 4.5% loss is also anchoring the DAX. There’s a slim chance that the ongoing rout in the euro could encourage equity investors to return later, though there’s no sign of that happening yet.

BoE may resort to smoke and mirrors

Sterling’s latest multi-month low ahead of the Bank of England policy decisions and statement is eloquent about expectations. Paradoxically, despite the uncertain medium-term outlook on the Bank rate, there is a lot to be sure about on Thursday. Rates won’t rise, and assets won’t be trimmed. Departing member Ian McCafferty would surprise many if he broke with long-time form to vote with the MPC for a hold. Michael Saunders would surprise somewhat less but has not signalled a change of mind of late. Hence the vote will probably remain 7-2. The scope of the MPC’s optimism on the economy is less predictable. Led by Governor Mark Carney, policymakers have suggested the impact of Britain’s weather-beaten slowdown will fade sufficiently in the near term for a further pre-emptive rate rise to cut inflation off at the pass. Such views are the chief reason for divergence between economists’ forecasts and market-implied probabilities. A majority of the former still project a 25-basis point rise in August. Futures suggest a hike by year end has 80% probability. But the date is free-floating. Only 40% probability is priced for August. Recent improvement in economic indicators has been modest enough to justify policymakers hanging back from clear pointers for now. So, as sterling against the dollar pushes towards $1.30 after a fortnight of almost continuous daily declines, a rebound is more likely to be triggered by profit taking than fundamentals. As always, it’s worth keeping the market’s capacity for over interpretation of nuance in mind. The BoE statement will have plenty.