Financial markets impacted by Italian political troubles

Published: Wed Jul 04 2018

Italy has seen more than its fair share of political troubles, problems, issues and upheavals. Italy even has a reputation for coalition governments and for governments that tend to have short shelf-lives.

As recently as May 2018 the problems emanating from Italy had impacted the European economic situation. So much so that the euro, which is the common currency used in Europe, saw a significant drop against the US dollar. The euro was trading at $1.15 against the US dollars. That the euro would be so much lower against an already weakened US dollar is certainly noteworthy.

Unfortunately for Italy, their financial situation has been in serious trouble for a number of years now. It has some of the highest unemployment rates in western Europe with unemployment registering in the double-digits. In addition, Italy is one of the largest debtor nations as its debts amounts to some 2.3 trillion euros! That, means it owes something like US$2.7 trillion or close to 132% of its GDP. Speaking of GDP, it is lamentable to note that Italy's GDP numbers are lower in 2018 than they were all the way back in 2005!

More recently, the markets have had yet another big problem to deal with in Italy. That problem has to do with the rise of populist movements in Italy. A case in point is how the Italian president was set against the appointment of a Eurosceptic to the position of finance minister. This back and forth in the political arena negatively impacted the markets.

In turn, the upheavals in the markets were serious and severe. Notably, the banks were hit quite hard with the largest bank in Italy suffering a precipitous drop in its share price of over 9%. The second largest bank in Italy saw its share price plummet by over 7%. All this banking volatility in Italy had jarring consequences on other European-based banks. The effect was so significant that even the markets in the USA were negatively impacted. Even treasury bonds, which are usually seen as safe, saw a drop in numbers not witnessed in over two years.

Then there is the not-so-delicate matter of Italian bonds. The team at Bouchard Fintech has highlighted the fact that Italian banks hold some six hundred billion euros in Italian bonds.

Additionally, the European Central Bank (ECB) itself is holding some three hundred and forty billion euros of Italian bonds. So, the ECB has a huge stake in how well things turn out in Italy and in Italy's financial well-being. Ironically, the populists in Italy have blamed the ECB for a variety of both perceived and imaginary problems. They point to how the ECB has pumped billions of dollars into the European economy using fiat money-in other words simply printing it.

The ECB, for its part, calls those free-wheeling money printing schemes quantitative easing. They point to the necessity of having those economic measures in place and extoll their many virtues. Still, simply printing more and more money and flooding the markets with borrowed, ultra-low-interest, money brings about its own set of financial concerns.

An unusual trend, given the above information, is how foreign debt holders have scaled back their Italian bonds. So, while Italy was issuing more and more bonds, international stakeholders were angling to lower their holdings. Notably, foreigners have reduced their Italian bonds by almost one half in the past three years. This trend is a harbinger of what the international bond markets think of Italian debt in general and of Italian bonds in particular.

In a sign of some economic turbulence, Italian bonds had to post slightly higher yield rates on their bonds in order to sell them. The amount of bonds being issued was not that big but in order to attract long-term investors the yields were raised. Still, the rates are still well-below the 4% mark. Should Italy be forced to raise bond yields to above 4% then there will be a host of other financial worries to deal with.

Where it gets much more worrying is how the populist movement in Italy moves forward. For, if the populists decide to take Italy in a different financial path, they may add to the existing concerns of investors, lenders and the banks. Additionally, if the populists decide to pick a financial fight with other European powerhouses, such as Germany, those worries would quickly multiply. Worst yet, if the populists decide to pick a fight with the whole European economic project, then that could lead to an upending of Italian financial stability. It may even bring about a period of financial upheaval and even financial chaos. Of course, time will tell and the rest of the world is waiting and watching to see where the Italian economic path will go.

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