Global Weekly: Italian government taking shape

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Bond markets continue to be driven by political risks arising from Italy, where the new government is being established by Lega and the 5 Star Movement. The two parties’ massive fiscal spending plan of around 6% of GDP will put pressure on the country’s long-term creditworthiness. Fortunately, the idea of a EUR 250 billion debt relief, which has been proclaimed within an unofficial and leaked draft, did not make it into the final agreement between the parties.

In the meanwhile, the government is being formed. Lawyer Giuseppe Conte is designated as the new prime minister. Rumours that the euro-sceptic hardliner Paolo Savona will be appointed as Minister of Finance seem not to materialize, which has been perceived as good news by investors.

Risk premiums of 10-year Italian government bonds compared to German Bunds increased to levels of around 190 basis points from around 130 basis points last week. As a consequence, also other European government bonds lost ground. German Bunds profited from the turbulence and the flight to safety. Yields decreased below 60 basis points. US Treasury yields were supported by a stronger US dollar, but  they came down as well to levels of around 3%, despite new tax reform announcements by US President Donald Trump. This risk-off tone is driven by a combination of geopolitical and fundamental developments in Europe and North Korea, as well as new uncertainties around the trade deal with China.

The US, China and Iran

Within equity markets, we saw a rise in volatility this week. The week started well with a moderate rise of stock markets, but on Wednesday, equity prices went down in European and emerging markets. Italian stocks lost most within Europe, after plans of the new government in Italy surfaced. Within emerging markets, Turkish, Brazilian, Indian, South African and East-European stocks lost more than the Asian stocks. The Turkish market suffered from the weak position of the lira.

The possible trade deal between the US and China was an important theme this week. On Sunday, US Treasury Secretary Steven Mnuchin announced that the administration agreed to put proposed tariffs on hold, while it is building on a framework for negotiations with China on trade issues.  The day after, the Chinese government declared that it would lower the import taxes for cars from 25% to 15% as of the 1st of July. The lower tariffs would not only apply to American car makers, but worldwide. As a result, BMW and Tata Motors (known for Jaguar Landrover) posted their biggest gains in a month. On Wednesday, however, Trump said that a US-China trade deal may be too hard to get done.

Possible sanctions for Iran also had a negative effect on the markets, because they would hurt worldwide trading volumes. In the period 2010-2015, USD 77 billion in trade had been lost, because of the sanctions imposed on Iran. European countries, South-Korea and Japan were hurt most, while there was just a minor effect on American companies.

Energy stocks showed the worst performance this week, followed by materials. This contributed to a weak performance for countries that are net exporters of oil and gas and basic materials, such as Brazil, South-Africa and Russia. Best performing sectors were IT and utilities.