Politics and Fixed Income trump FX

Italy and Greece look as if they are slowly coming to grips with their political crises. The potential formation of two credible, technocratic governments is trying to lift the markets back to the pre-Greek referendum bombshell.

The Italian senate is due to vote on the austerity measures later this morning, and the vote is expected to pass with ease. The bill then continues on to the lower house tomorrow to get voted on and, again, is expected to pass. This will pave the way for Berlusconi to resign. By Monday, when North American desks are filled again, the market should be faced with a new government under Mario Monti, who happens to be another economist.

The new coalition will be supportive of the crucial 5-year BTP auction by the Tesoro on Monday morning. Currently, the ECB and Euro dealers continue to drive yields lower after Wednesday’s 10-year high, which broke the psychological +7% aggressively (+6.60%). So far, the best thing to have come out of all this is the FX market coming to grips with yields, foreign yields especially, and understanding some of the more key triggering yield points. Bund spreads are now becoming second nature to FX!

In Greece, new Prime Minister Papademos is scheduled to name a new cabinet later this morning. They will be entrusted with trying to push through their “massively unpopular austerity measures”, needed to receive the next tranche of the bailout. It’s a politically correct step but, economically and socially, we have to wait for those results.

How much comfort with these developments can the markets expect? It’s difficult to stop the rot entirely. Will these political changes have the legs to extend market gains next week? The downward revisions to EU growth forecasts highlight risks in the area. This should have a far reaching effect on risk appetite, once we get to focus again on fundamentals.

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