Summary
Coordinated signals, subtle and vague from the leaders of Italy’s coalition government, are underpinning European stock markets again.
Italian coalition blinks
The mood—which is also contributing some buoyancy to U.S. stock futures— is reminiscent of sentiment that accompanied a handful of bounces last week. Then, it also appeared deputy prime ministers Salvini and Di Maio were considering a possible compromise with Brussels.
With European shares still markedly underperforming Wall Street this year, even after the latter’s ‘catch down’ in recent months, the pattern of corrective bounces has been quite prevalent.
One key difference on Monday is that Italian politicians have made little attempt—unlike last week—to re-shape the market’s optimistic interpretations. Both Matteo Salvini and Luigi Di Maio have hinted in separate comments that they are open to lowering the deficit target for next year’s budget. Doing so would avoid a disciplinary procedure from the European Union that could rekindle the significant volatility in stocks and bonds that have been a frequent Italian market feature this year. "What is important is that the budget contains the goals that we have established," Di Maio said later. "Then if the negotiation means that the deficit (target) must come down a bit, for us it's not important."
The draft deficit goal of 2.4% may come down to 2%, according to reports. The result of these comments is the biggest drop in the closely watched spread between Italy’s 10-year government bond (BTP) yield and 10-year bund yields since June.
Of interest to technical chart watchers: the Italian yield is trading below the rough 3.30% area for the first time since early November.
Optimism will have limits this week
As we suspected last Friday, the optimistic interpretation does indeed seem to be gaining precedence, as the government is increasingly willing to be open about its formula for a way out of the impasse. This latest sign that compromise may be possible may turn out to be rather late.
The first steps in the EU’s excessive deficit procedure have already been taken, with member states invited to examine the European Commission’s findings. The coalition’s propensity for equivocal public stances could also come back into play, as it has on other occasions when pragmatism appeared to be set to break out.
Elsewhere, the government remains just as committed to difficult-to-square spending plans. In short, with significant headline risk built in this week, and in the weeks just ahead, we expect the limits of market optimism over Italy to be palpable.
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