Eurozone: Italy and Germany in focus - BBH

Analysts at BBH suggest that the two big political events on March 4 may also influence investors in the days ahead as the Italian election will be held and the results of Germany's SPD decision on forming another grand coalition with Merkel's CDU/CSU.  

Key Quotes

“Merkel's center-right coalition is expected to endorse the grand coalition early next week. 
Polls suggest the SPD will, in fact, endorse the coalition.  The failure to do so could spur a sharp decline in the euro.  It would force either a minority government or new elections.  New elections are risky.  Polls show that popular support for the SPD has continued to fall since last September's election and that it is now in third place behind not only the CDU/CSU but the populist AfD as well.  If new elections are needed, it is less clear that Merkel will survive as Chancellor, and it raises questions about new initiatives in Europe this year.”

“The Italian elections were seen as the major European political risk this year.  The polls before the blackout period had the center-right getting the most votes, but not a majority.  Polls showed a battle for second between the center-left and the Five-Star Movement.  A splinter group that broke away from the center-left PD over a disagreement with Renzi could account for the difference.”

“Like others, we had thought that in the run-up to the election, Italian asset would underperform, but they have not.   Italy's 10-year yield has risen six basis points this year.  Germany's 10-year yield is up nearly 23 bp.  Spain is a more comparative asset to Italy than Germany.  Its yield is up three basis points.  Portugal's 10-year yield is up 13 bp.”

“The short-end of the coupon curve tells a similar story.  Italy's two-year yield has risen 10 bp this year; so has Germany's.  Spain's two-year yield has risen 21 bp and Portugal 17 bp.  Italy's stock market (FTSE-Milan) is the best performing in the G7 this year.  It is up 3.75%.   Germany's DAX is off 3.4%, Spain's IBEX is off 2.2%, and the Dow Jones Stoxx 600 is off 2.1%.”

“We suspect the most likely result is that the center of the center-right bloc and the center of the center-left bloc form a government after some false starts.  The odds seem to favor EU Parliament President and a member of Berlusconi's Forza Italia as the next Prime Minister.”