Berlusconi’s Pressure Cooker Effect

by Ivan Martchev | February 25, 2013 7:00 am

Italian elections on Feb. 24 might decide the next phase in the eurozone drama, as Silvio Berlusconi’s coalition is a close second behind front-runner Pier Luigi Bersani. Berlusconi is campaigning on an anti-austerity platform that, if implemented, could cause a surge in Italian government bond yields that starts the next phase in the eurozone crisis.

Campaigning on an anti-austerity platform is the populist thing to do in Europe in times of high unemployment and sluggish economic growth, yet it is the belt-tightening by outgoing Prime Minister Mario Monti that allowed Italian 10-year sovereign bond yields to decline from a record high of 7.26% in November 2011 to the present 4.41%.

As Berlusconi’s coalition gained in the polls during the past six weeks, Italian bond yields surged by about 50 basis points like a real-life barometer of Italy’s political landscape.

Polling in Italy is banned two weeks before the election, so there is no statistical way to gauge how close Il Calaiere is to becoming yet again a prime minister, but European sovereign bond[1] markets are open for business, and they will be sending real-time signals as to which way the political wind is blowing.

I have thought all along that the key to the solution of the eurozone crisis[2] is fiscal integration, as 17 finance ministers sometimes working in direct contradiction with a single monetary policy is not a workable solution. No such fiscal integration has materialized, so the present eerie calm in Europe is deceptive. The eurozone drama commenced with Greece, but is likely to end with Italy or Spain (the largest members of the fiscally irresponsible PIIGS gang).

It appears the better part of the stabilization rally in euro-denominated assets — which accelerated last September with the unlimited conditional offer to buy eurozone sovereign bonds by the ECB — is done. Italian government bonds yielded as high as 6.6% last July, just before the conditional offer was made by the ECB. At present, they yield 4.41%. Many major European bank shares have risen by 50% to 70% since last summer — arguably, from very depressed valuations — and are unlikely to keep rising if the economic data coming out of Europe keeps deteriorating.

I would keep a close eye on all indicators of rising financial stress in Europe, like bund-eurozone sovereign bond[3] spreads, the euro/Swiss franc (EURCHF) exchange rate and Swiss two-year notes.

The EURCHF rate was barely contained[4] at 1.20 by the Swiss National Bank and has moved above the floor set by the bank (currently near 1.25). Any indication that the EURCHF drifts toward 1.20 is an indication for the rising preference to hold CHF over EUR and a sign of capital outflows from problematic eurozone countries.

The SNB intervention in the forex market was not followed by an intervention in the Swiss government bond market, which caused investors to pile into Swiss two-year notes and resulted in persisting negative yields[5] from April 24, 2012 to Jan. 16, 2013. (If investors buy two-year notes with negative yields, they get exchanged at the prevailing EURCHF rate at the time of purchase, but receive Swiss francs at the time of maturity, therefore betting that EURCHF will have moved in their favor in that time frame, with or without SNB intervention).

There are only 6 listed Italian ADRs and ETFs, but they are not likely the best way to play any repercussions from the coming elections. Italian financial markets are still captives of the eurozone crisis, so they will move with the rest of the PIIGS financial markets. As different as they are, the country iShares for Italy and Spain have moved virtually in lockstep[6] throughout the eurozone crisis.

There are no ADRs of Italian banks, but there are two from Spain — Santander (NYSE:SAN[7]) and BBVA (NYSE:BBVA[8]). Eurozone financials are the most exposed to rising stress in sovereign debt markets as they own a lot of eurozone bonds and their day-to-day lending operations are directly affected by the level of market-driven interest rates in Europe. Major banks in Spain and Italy would likely behave similarly, as the Italian government bond market affects the Spanish government bond market — the country-specific iShares funds clearly show it.

If Berlusconi wins, I suspect the stabilization in eurozone sovereign debt markets helped by the ECB — which came despite deteriorating indicators of eurozone economic growth — will come to an end.

It looks like we are setting up for a repetition of last summer’s eurozone drama.

Ivan Martchev is a research consultant with institutional money manager Navellier & Associates. The opinions expressed are his own. Navellier & Associates does not hold positions in any stocks mentioned in this article for its clients. This is neither a recommendation to buy nor sell the stocks mentioned in this article. Investors should consult their financial adviser prior to making any decision to buy or sell the aforementioned securities. Investing in non-U.S. securities including ADRs involves significant risks, such as fluctuation of exchange rates, that may have adverse effects on the value of the security. Securities of some foreign companies may be less liquid and prices more volatile. Information regarding securities of non-U.S. issuers may be limited.

  1. sovereign bond:
  2. eurozone crisis:
  3. sovereign bond:
  4. barely contained:
  5. negative yields:
  6. have moved virtually in lockstep:
  7. SAN:
  8. BBVA:

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