Cataclysm In The Euro As Italian Politics Hit 'Punto Morto'

Includes: ERO, EU, FXE, UDN, UUP
by: FXstreet

Looks like turbulent times lie ahead for the interest of the euro, as Italy finds itself in a major political mess, with the Senate in a state of deadlock after no party won a majority. The lower house, which will be controlled by Pier Luigi Bersani's center-left coalition, does little to help a recovery in sentiment.

As explained earlier today,

the results show a fragmented Italian society, where almost 1/4 of the population failed to turn up at the polling stations, but most worrisome of all is the situation in the Senate, where even with Monti's support, neither Bersani's nor Grillo's party will be able to pass key laws it appears, thus heightening fears about the non-viability to pursue the same austeritarian path Italy had undertaken under Monti's technocrat government...

A temporary hung parliament through a grand coalition government it is now being rumored, according to WSJ and FT, though.

While the Wall Street Journal speculates that attempts for a temporary grand coalition government of left and right-wing powers may be possible, with the sole purpose of modifying Italy's electoral law and go back to vote before summer.

Meanwhile, Wolfgang Munchau, from the Financial Times, argues that the "case for a grand coalition in Italy" is strong. "The situation is not comparable to that of Greece, where after an initial election last year it was simply not possible to form a government. In Italy, by contrast, there exists a solution to break the political gridlock: a Grand Coalition. And if there is a rerun of these elections, the overall outcome may still be the same."

Will markets give the euro the benefit of the doubt? According to Westpac FX strategist Robert Rennie,

time will tell how workable this theory is, but having been badly burned overnight, financial markets will be in no mood to give the benefit of the doubt and wait for a grand coalition to be formed and possibly break apart.

Another important development from Monday's Italian election results is the growing discontent towards austerity measures, with the landslide defeat of Mario Monti's technocrat party reinforcing the idea of austerity policies playing against one's party. Moreover, another reason to be concerned is that a discredited and controversial politician like Silvio Berlusconi is still able to get significant support from the Italian electorate, a warning signal of the anti-austerity feeling shared all over Europe.

Short-term talking though, attention towards Italy will need to be finely balanced with another risk event taking place at 15 GMT, when Fed Governor Ben Bernanke commences his 2-day testimony to Congress on monetary policy and on the economy on February 26 and 27. His comments will influence the volatility of the USD, and are expected to shed a light after the last Fed's minutes induced volatility, in which the USD rose strongly.

On the possible EUR/USD direction, Westpac's Mr. Rennie comments:

In our view, EUR probably still bounces into and during Bernanke's testimony later today. Bernanke is sure to push back against the hawks who have been fretting over the long-term costs of Fed asset purchases. He is likely to repeat that the Fed is still well short of its goals when it comes to the U.S. labor market as well. But, beyond a short-term pop in EUR there is no denying that the EUR is in a clear downtrend from early February.

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