Article / 11 November 2016 at 6:00 GMT

3 Numbers: Bond auction, reform vote shift focus to crisis-prone Italy

Blogger / MoreLiver's Daily
  • Watch for a possible credit rating downgrade for Italy following its bond auction
  • Italian bonds will draw little interest – the yield is too low and the risk too high
  • Italy's woes will create headaches for other Eurozone leaders
  • Fed's Stanley Fischer should continue to suggest a December hike in his speech
  • Any dip in US consumer sentiment at the start of November will be just a blip
By Juhani Huopainen

Now that the US elections are out of the way, we have precious little information about the kind of economic policy or even the officials that Donald Trump’s presidency will deliver.

The focus could begin shifting back to Europe. That part of the world is about to provide plenty of political risks toward the end of 2016 and again in 2017. And on the energy front, Opec’s monthly report comes out at 1100 GMT.

Italians will vote on key structural reforms on December 4, and prime minister Matteo Renzi, above, has put his credibility behind the reform package. Photo: iStock

Italy Bond Auction (1030 GMT). Italy’s Treasury will auction off its three, seven and 30-year government bonds today. The bond auctions were a big thing during the wilder euro crisis days in 2011-2012, but have attracted little attention for a long time. European Central Bank support, first in the form of “whatever it takes” promise and then the bond purchase programme, have masked Italy's high level of debt, its weak banking system and most importantly the nation's low growth.

This complacency about Italy could now be changing. Inflation expectations have been rising for some time now, the ECB’s continued support could prove politically difficult in 2017, and Italy’s risk premiums over Germany and equally-troubled Spain have been rising. Italy is too large to be allowed to fail as the EU’s new rules require. But no more bank bailouts are likely. Italy is too large to be bailed out by the rest of the Europe, and mustering the required levels of support around the German and French elections is impossible without a political backlash.

Now that US yields and inflation expectations are rising on Donald Trump’s win, Italian bonds are of little interest to investors – the yield is simply too low and the risk too high. If the yield rises, Italy’s situation gets worse, so the risk cannot be compensated by higher yields.

Italian bonds
Italy yield

Chart source:

Italian and European stock indices, performance since the 2009 bottomITaly EU

Chart source: Saxo Trader

Italian and European stock indices, performance this year
Italy EU shorter

December Referendum a key political risk

Italy will hold a referendum on a constitutional reform package on December 4. The package aims to improve stability of the country’s political system and increase the powers of the government. If the reform package referendum is not passed, Italy would be unlikely to implement economic structural reforms – something that an indebted member of the European Monetary Union would sorely need.

The country’s young prime minister, Matteo Renzi, has put his credibility behind the reform package. If the referendum does not pass it, Renzi’s days could be numbered. Even if Renzi does hang on and the government doesn't collapse, there is little that can be done to alleviate Italy’s economic situation within the euro zone.

Ratings outlook for Italy

The credit rating agency S&P has a prescheduled opportunity to change Italy’s ratings outlook today after the market closes. The current rating is BBB- with a stable outlook. If the S&P wants to adjust its rating, it would first have to switch its outlook from stable to negative.

If investors begin to worry more about Italy’s prospects, that would require some sort of reaction from the core Eurozone countries. And that would be needed just when Eurozone leaders would least like to remind their voters that in the euro area, any member’s problems are problems for all of them. The possibility of a negative feedback loop is high.

On the other hand, investors know all of the above. Perhaps Italian stocks and bonds provide good value at the moment. The referendum might go through, or if it doesn't, Renzi might hold on, and maybe the rest of the euro area will come up with a way to keep Italy humming at least until the German and French elections are over. Most likely the European Central Bank would be on the rescue & support detail.

US Federal Reserve speech (1400 GMT). Fed vice chairman Stanley Fischer will be speaking in Chile on “US Monetary Policy and the Global Economy”. Fischer will probably signal that the December’s rate hike is very likely, as the shock in the financial markets remained limited right after the presidential elections.

The current market-implied probability of the December hike is over 80% – it hit a low of 50% when the election results came out. Even though the December hike probability is already very high, his speech could help push the bond yields and the USD a little higher.

US November U.Michigan Consumer Sentiment (1500 GMT). The flash consumer sentiment is expected to be 87.5 – only slightly higher than the 87.2 October reading.

The consumer sentiment has mostly drifted unchanged at relatively high levels since the beginning of 2015. The recent reading was as low as the 2015 low.
Us sentiment

Chart source: Saxo Bank. Create your own charts with SaxoTrader; click here to learn more.

The economic recovery is stable, slow and has gone on for a long time now. The Fed seems to know what is best, and has been slow to hike rates. This has stabilized the consumers’ expectations as well.

The early part of November included scaremongering of an economic recession and a stock market crash should Trump get elected. The November survey data was collected before the election outcome and the limited market reaction to the vote were known. It could be that confidence took a hit, but market commentators would be quick to understand that the hit was temporary and based on something that really did not happen.

There are plenty of disappointed people who will stick to their beliefs that Trump will eventually kill the economy. This could could show up in the sentiment index for a while, but I don’t believe it will. The Brexit referendum taught us that even though people are publicly complaining how things will get worse, they will act differently in making economic decisions. Call it double standards, or call them sore losers or name it cognitive dissonance, but a possible dip in the consumer sentiment should be considered old news and temporary.

– Edited by Robert Ryan

Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform.


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