Market Reaction

Why so Chill?

  • Why it matters

    Why it matters

    Italy’s “No” vote was widely expected, and investor sentiment has been further bolstered by the country’s protection under the European Central Bank.

  • Facts


    • Germany’s blue-chip DAX was trading up 1.6 percent and the Euro-Stoxx 50 was up more than 1 percent on Monday afternoon.
    • Italy’s government bonds are also not taking a serious hit. Yields on 10-year government bonds rose just 0.11 percentage points to around 2 percent.
    • More and more experts have been arguing that the 35-year bull market in bonds is coming to an end.
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Stock Market Reaction As Italy’s Rejects Renzi’s Referendum
What else is on TV? Markets shrugged off Italian Prime Minister Matteo Renzi's announcement that he was resigning on Monday. Source: Bloomberg

It’s a little strange to say the least. Italy just kicked its young and reform-minded prime minister out of office, yet stock and bond markets have shrugged it off as if nothing happened. In fact, they almost seem to be happy about it.

Germany’s blue-chip DAX was trading up 1.6 percent Monday afternoon. The Euro-Stoxx 50 was up more than 1 percent. Even Italy’s own stock exchange in Milan shrugged off its losses and spent some of the day in positive territory, though it was down again slightly by later in the afternoon.

Germany’s Finance Minister Wolfgang Schäuble said he was “relaxed” about the outcome. Speaking in Brussels at a meeting of euro zone finance ministers, he said there was “no reason to speak of a new euro crisis.”

So what’s the catch?

For many it seems to be a classic case of “sell the rumor, buy the news” to reverse the classic market adage.

It’s not the reaction anybody really expected, nor was it the immediate response of investors. Italy’s FTSE MIB index tumbled on opening and the euro fell to a 20-year low against Asian currencies. But by the afternoon, most markets across Europe hadn’t just recovered their losses – they were gaining.

For many it seems to be a classic case of “sell the rumor, buy the news” to reverse the classic market adage. Italy’s referendum result, in which the country rejected a series of constitutional reforms that had been pushed by Prime Minister Mattro Renzi, was widely expected.

It wasn’t a difficult call. Polls had suggested Mr. Renzi would lose. And in any case, 2016 hasn’t exactly been a year of the establishment winning elections and referenda.

In other words, markets had already priced in a “No” vote from Italy. That, coupled with a positive surprise from Austria, where a presidential election Sunday saw a seemingly popular far-right presidential candidate rejected, goes some way to explaining the rather sanguine reaction on Monday.

“The markets have learned from the political shifts that 2016 has brought,” said Heinz-Werner Rapp, chief investment officer of the asset manager Feri.

Another explanation: It’s not as if Italy had no problems before Sunday’s result. The government has been struggling for years to revive growth and repair unhealthy banks. Those problems weren’t going to go away, even if Mr. Renzi had survived with a “Yes” vote on Sunday.

“The problems in Italy haven’t changed because of the referendum,” Volker Wieland, a German economist and leading government advisor told Handelsblatt. “Its economic performance remains well below the level before the outbreak of the 2008 financial crisis and per head it is even a little below the introduction of the euro.”

Not even Italy’s government bonds are taking a serious hit. Yields on 10-year government bonds rose just 0.11 percentage points to around 2 percent – hardly a crisis scenario. Back in the heady days of Europe’s debt crisis from 2010 to 2012, bond yields of struggling southern European countries hit 7 percent and higher.

Mr. Wieland said this is largely because Italy is effectively under the protection of the European Central Bank, which has bought more than a trillion euros in bonds and pushed down yields across Europe for the past year. That could change in the coming months if the economy continues to languish. Mr. Wieland went as far as to suggest that Italy should take advantage of what’s on offer in Europe these days and request an aid program under the European Stability Mechanism, or ESM, a firewall set up after the 2010 crisis that is also backed by the ECB.

“Italy quickly needs a functioning government,” Mr. Wieland said. An aid program under the ESM, together with the International Monetary Fund, could force Italy to get serious about the kinds of economic reforms it needs to sustain itself over the long haul, he added.

But perhaps most surprisingly, given the worries of wider political fallout, investors aren’t fleeing to safer assets. Market participants were selling safe German bonds (known as Bunds) on Monday too, pushing interest rates on 10-year debt above 0.3 percent, up about 0.04 percentage points from Friday.

“Before the referendum in Italy, bund yields had already fallen significantly, so the odds of a further drop was limited,” said Christoph Rieger, head of interest and credit strategies at Commerzbank.

Mr. Rieger noted that things weren’t really any different after Britain’s E.U. referendum or Donald Trump’s election in the United States. The “shock and flight into safe assets only lasted a brief while,” he said.

Nevertherless, the rise in Bund yields is particularly remarkable. But it may have less to do with Italy and more to do with a broader troubling trend.

Until the autumn months, Bunds had only been moving in one direction: Yields went down as demand and prices went up. In fact, 10-year Bunds reached a historic low yield of negative 0.2 percent back in June – meaning investors were actually paying the government to buy bonds – and were still around minus 0.15 percent in September.

But the wind has been changing since then. More and more experts have been arguing that the 35-year bull market in bonds is coming to an end. Inflation is expected to rise in the coming years both in the United States and Europe, a trend that Donald Trump’s election in the United States has only fed further.

That has sparked uncertainty among investors – even German bunds are no longer quite as safe as they once were.


Andrea Cünnen, Jan Mallien, Christopher Cermak and others contributed to this story. To contact the authors:

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