Politics triggers spread volatility
The final quarter of 2013 looks set to be plagued by political instability on both sides of the Atlantic.
Italy's CDS widened 16bps to 280bps this morning following weekend news that former Prime Minister Silvio Berlusconi ordered his five ministers to resign from the cabinet. The coalition government formed earlier this year has always been fragile, but Berlusconi's intervention brings its continued existence into serious doubt.
A no confidence vote is scheduled for Wednesday, with Berlusconi urging his members to vote against the government. However, he may not get his way if reports emerging this afternoon are to be believed.
As many as 20 senators belonging to Berlusconi's PDL party could rebel and form a breakaway party unless the former PM backs down, according to reports. If true, this may enable current PM Enrico Letta to salvage the government and avoid fresh elections.
The news had a positive effect on the markets. By mid-afternoon Italy's CDS were only 7bps wider at 271bps, and the Markit iTraxx Europe recovered earlier losses and was trading 2bps wider at 104.5bps. Predictably, Italian banks and corporates were the worst performers, but they stemmed their deterioration in tandem with the sovereign.
The market reaction today should also be kept in historical context. Italy's 16bps widening this morning was modest in comparison to the 45bps daily move seen after the election in February, and insignificant compared to the panic conditions of the sovereign debt crisis.
Even with the recent widening, Italy's spreads are still about 300bps tighter than where they were trading in July 2012. That date is crucial to understanding why Italy's CDS haven't blown out during this latest bout of political turmoil. ECB President Mario Draghi famously declared he would do "whatever it takes" to save the euro, and shortly afterwards introduced the Outright Monetary Transactions programme.
These measures have reduced systemic risk in the eurozone and helped spreads rally to more "normal" levels. It is no coincidence that the other peripheral sovereigns have barely felt the impact of Italy's problems, which would have been unthinkable before the ECB's intervention.
Over in the US, the credit market reaction to a possible shutdown of the US government was also controlled. The Markit CDX.NA.IG was just 1.5bps wider at 82.5bps after Congress failed to reach agreement and therefore increased the chances of a shutdown.
One of many consequences could be that the non-farm payrolls report due this Friday won't be released. News from the negotiations will help shape spread direction in the US today and in Europe tomorrow.