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Italy – Wake up and smell the coffee

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It looks like the market has reacted with some cheer to the news that Silvio Berlusconi has stepped down as Italian Prime Minister with his successor Mario Monti asked to form a new government following approval of a reform package by the Italian parliament on Saturday, says Anthony Gillham (pictured), portfolio manager at Skandia Investment Group (SIG)…

Italian 10 year government bond yields had hit around 7.5% last week, levels that were said to have triggered bail outs in other peripheral European markets, but on Friday dropped to around 6.5%. Risk assets are firmer as a result.

While the cheer is understandable given Monti’s track record as a European Union commissioner and the expectation that his technocratic government will be able to unite the various Italian political factions behind a common cause, the fact remains that Monti is unelected to this position and lacks a popular mandate. This is not sustainable in the long run.

We should also remember that at a spread of nearly 4.7% to German Bunds, a 6.5% yield for Italian 10 year government bonds is not a reason to celebrate, a fact underlined by LCH Clearnet’s decision to increase margin requirements for Italian government bonds.

With the president of Germany’s Bundesbank re-affirming opposition to ECB intervention in bond markets it is clear that a solution to the Eurozone crisis remains some way off and steps to it mired in execution risk; financial market volatility could be here to stay for some time longer. So wake up and smell the coffee!

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