Italy took centre stage yesterday after the inconclusive result from the general election.
Price action in Italian Government bonds is certainly not positive for the markets. After an initial weak opening, domestic institutions took prices higher and yields lower after the initial re-pricing of the yield curve.
The gradual selling throughout most of the day, or perhaps it should be described as a lack of buying, meant that Italian Government bonds ended the day close to the day’s high in yields. It does not bode well for today as there are auctions of €2.5bln BTPS 3.5 11/17 and €4bln new BTPS 4.5% 2023. Primary dealers will potentially have to buy €200mln each of the new 10yr and that means that it is likely that there will be a need to build in a bigger new issue concession into the market tomorrow morning.
Certainly today there were few investors actively buying the market. The “Big 4” Italian Funds apparently sat on their hands today and will take their time in making any strategic decision here.
So this morning 10yr BTPS are likely to test the 5% yield level.
So if 10yr Italian BTPS are set to hit 5% the Euro should weaken even further. And there should be a general risk off day again.
The US market saw its risk sell-off Monday, but even yesterday the normal rebound in risk assets looked to be running out of steam. Certainly the Economic data releases had been a lot stronger than the market had been expecting, with housing certainly showing some signs of a continuing recovery. However the Federal Reserve Chairman brought some reasoning to the markets in his assesment of the US economy and the upcoming forced austerity, the automatic sequester, that will take effect at the end of this week. Unlike most US Investment banks the Fed Chairman painted a gloomy picture for the US economy if and when the automatic spending cuts kick in. It seems similar to the payroll tax hike that most investment banks have tried to forget but that is seen as having a marked impact on household spending now.
US Treasury markets gave up some of the gains seen on Monday yesterday, but given the near 1% recovery in the Dow, the small change in the Treasury yield curve shows that investors are back to looking for some protection. 10yr US Treasury yields closed the day very close to the 55 day moving average, 1.864%. Some analysts have used this as a reason to recommend some selling but it wouldn’t take much for this technical resistance level to be broken and for yields to move towards the 200 day m.a 1.71%. This may well occur as we go into month-end, Index based Funds face a large increase in duration and would certainly be aided by a rise in Italian bond yields.
And another sign that investors are desperate to add some portfolio protection, Gold had a sharp rally yesterday. As the Fed Chairman was speaking US$ gold rallied $35 and tested the $1620/toz.
With European bank credit spreads set to widen from here, then Euro Gold should also be well supported and should move higher in the coming days. Look for European Financial spreads to move up significantly on more Italian pressures and as such we should see Financial Spreads move back to potentially 200bp, currently 165bp, and that would drag Euro Gold back towards €1300/toz