Markets were thrown into turmoil this week following Sergio Mattarella’s – the president of Italy – decision to block the appointment of a eurosceptic finance minister, Paulo Savona, nominated by the populist Five Star Movement (M5S) and right-wing League parties, which are attempting to form a coalition government after elections in March.
Instead, Mattarella appointed a caretaker prime minister and another bout of elections are now widely expected in the coming months.
These latest events have pushed markets – already nervous since the inconclusive Italian elections in March – into a global stock selloff. Italy’s benchmark stock index fell nearly 2.7%, and concerned investors sold off government bonds, sending prices down and yields up.
The yield on Italy’s main 10-year bond rose to its highest level in more than four years, spiking by more than a half percentage point to roughly 3.20%, according to data from Tradeweb.
This week has seen the euro fall to an 11-month low and sent Italy’s short-term borrowing costs to their highest for five years. Furthermore, Moody’s ratings agency has put the country’s credit rating “on review” for a possible downgrade.
Stock markets in the United States also dropped on Tuesday amid concerns that growing political uncertainty in Italy and simmering tensions over Chinese trade could weigh on global economic growth.
Then on Wednesday, Italian stocks staged a modest recovery and government bond yields settled below the highs prompted by Tuesday’s turmoil. Foreign exchanges were quieter and the euro rallied slightly.
However, for the European establishment the idea of an outright Eurosceptic election victory in Italy is very real. The fear then is that the financial situation could spiral out of control, should a new government seek to blow EU rules on debts and deficits out of the water.
Amid that uncertainty — which has left open the prospect of early elections and the formation of another populist alliance — investors have suddenly shifted away from riskier investments like stocks and commodities and taken refuge in the relative safety of German and American government bonds, the United States dollar and the Japanese yen.
In a note to clients, bond market analysts from BMO Capital Markets thought that the shift toward investor demand for safety would probably last.
“The cracks that we’ve seen in risk appetite are only likely to widen,” they wrote.
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