Like Columbus, Italy continues to navigate through some uncharted waters. The Italian sovereign debt market faced a major test this morning with the Italian Treasury tapping the 5-year bucket for around +€3b and issuing +€2.5b of a new 10-year product. This was never going to be the ideal time for Italy to come to the market amidst post-general election uncertainty. Despite everything, the auctions outcome is being viewed as an early test of market risk appetite following last weekend’s inconclusive election results.
The results of the BTP auctions look strong given the circumstances, with good overall bidding and firm covers. The full +EUR6.5b out of the target +EUR4.75-6.5b has been filled. Especially in the 10′s bucket, the issue received +EUR6.6b in total bids, well above the +EUR5.2b three-issue average. The results happened to produce the strongest cover for a new 10-year issue in nine-years. The bonds were sold at an average gross yield of +4.83%, up from +4.17% in January. Creeping yields are not debilitating, but it’s a worry to some investors.
Political backlash against austerity reforms in Italy, as well as in Portugal and elsewhere, is driving yield divergence and was the hallmark of past euro-crisis. Current euro data and this morning’s auction results are so far not enough to convince the market that this week’s EUR correction is somewhat overdone. Investors' initial reaction after the Italian issues is to once again sell the single currency despite the decent cover coming at the expense of higher yields. Any eurozone spread widening to the U.S. will only continue to weigh on the "single currency."
Follow EUR/JPY, it’s in a position to reveal to the market the most clues. Prime Minister Abe’s “reflation” techniques are so far struggling to maintain a weaker yen consistency. Japanese authorities are mindful of losing the battle now that EUR/JPY trades heavy. A bearish reversal for the cross is currently underway and is beginning to expose previously not thought of monthly levels close to 117. Can the currency pair maintain its negative course?
Once bitten twice shy! Will the ECB come to the rescue? The markets expect that they will act as savior and backstop in a “last resort” capacity if /and or when Italy lacks a stable government or in a more grave scenario, when Italy loses access to the debt markets. Do not be surprised to see the markets begin to question the effectiveness of the ECB’s plan to act as backstop to the periphery economies with its bond buying programs (Outright Monetary Transactions). The current sell-down of risk assets is the biggest test so far of euro’s newfound composure since the financial crisis. While the downside risks are blatantly clear, euro policymakers are touting a financial system that is supposedly more robust than it was prior to the ECB’s creation of the OMT. Let’s hope so.
Chairman Bernanke will testify before the House Financial Services Committee this morning for round two of his semi-annual testimony. What’s next now that “Helicopter” Ben has gone public and reinforced his commitment to the Fed’s bond buying program? Last week’s FOMC minutes happened to spook capital markets. Bernanke has turned the tables and correctly argues that greater uncertainty can only be damaging to the U.S. economy in the long run. In yesterday’s senate bank committee testimony, Bernanke believes that the potential cost of increased risk taking to date does not outweigh the benefits of promoting a stronger U.S. job and economic growth environment.
So far a low U.S. interest rate environment has led to the availability of cheap money for a housing and consumer durable recovery. The Fed requires help; they cannot be expected to shoulder the “entire” load. This is similar to outgoing BoE governor King’s rhetoric of last week when they too reached out and sought further commitment from Cameron’s government. Ben is looking for more of a pledge to the upcoming “sequester” or federal budget cuts. Instead of across the board cuts to the federal budget, “policies that reduce the federal deficit more gradually in the short term and more substantially in the longer term” should be phased in. Tepid U.S. economic growth is not strong enough to withstand a significant near term burden on the economy. By last count, analysts expect economic growth to be shaved by -0.6% by Friday’s impending “sequester.”
Despite the EUR opening better bid, the unit has failed to take out key resistance levels on top. It certainly had the opportunity to do so after the Italian auction, however, “buy rumor sell fact” has dominated the markets first moves. Overall, political uncertainty is likely to keep the EUR vulnerable near term. But, will the Italian election results cause a return to the high levels of stress experienced last year amongst the peripheries? Fresh buy EUR orders below are viewing this as a correction and a long EUR potential buying opportunity. The key to the puzzle probably rests with the credit agencies and their views on Italian credit worthiness. Maybe their reports will be the EUR’s next phase catalyst.