Italian politics hammers markets on concerns over euro membership

The Italian president has rejected the appointment of a eurosceptic finance minister, but his decision to stand up to the populist parties could backfire and give them a stronger hand in the future. Markets are unnerved.

Investors are spooked. Stock prices are down, the euro is down, Italian bonds are routed, safe haven assets like gold and the Japanese yen are rising. The reason? Italian political uncertainty after the country's president, Sergio Mattarella, decided to reject the coalition’s choice of a eurosceptic finance minister.

Bank of Italy Governor Ignazio Visco has warned that the country is now just short of losing the ‘asset of trust’. Some may argue that has already happened in the markets after the yield on Italian two-year bonds broke above 2% for the first time since the European bond market crisis of 2013, with one of the biggest intraday spikes ever seen in the bond markets.

Italian politics is normally uncertain. Now it is perceived as dangerous. Concerns centre around what might happen at another Italian general election, currently looking likely to be set for either September or October.

On the face of it, Mattarella thinks he is facing down the populist Five Star Movement and League coalition after they proposed eurosceptic Paolo Savona as finance minister – a step too far for the Italian president. He feared Savona could drive Italy out of the euro, and has instead installed a technocrat professor, Carlo Cottarelli, as Prime Minister, but Cottarelli is not expected to survive a vote of no confidence, and another election will then be triggered.

Mattarella’s move could strengthen the position of Five Star and League in those elections, and they will come back in a stronger position to force through their plans. The populist parties are already framing this as an effort by the Brussels-led Italian establishment to block the will of the people. Mattarella already has limited powers, and will be weakened if Five Star and League win bigger shares of the vote with clearly Eurosceptic policies next time round.

Where next for the euro and Italian stocks?

The euro has been sharply declining for over a month now, following an impressive bull run throughout 2017. However, there are signs to say that the bullish phase could be over, with a more bearish outlook in play. Key to that is the ability to break below $1.1554 which would bring about the first long-term lower low since the start of 2017. With the price currently challenging that level, any EUR/USD trader should keep an eye out for exactly how the pair responds to it. With the long-term picture showing a bearish sell-off in the wake of a move into the confluence of trendline, 200 simple moving average (SMA), and Fibonacci resistance, the confirmation of a long-term bearish trend coming back into play would be established with a break below $1.1554.

From a stock perspective, we also have a hugely significant level in play, with the current market anxiety causing a sharp deterioration into the 21,270 level for the Italian FTSE MIB index. The precursor to this was a rally and rejection of the crucial 24,044-24,568 resistance zone, which has capped all price action over the past decade. With the index turning lower from a major resistance zone, a solid break below this 21,270 level would signify a bearish signal which could spark a substantial period of downside for the index.

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