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March 12 (Bloomberg) -- Foreign-exchange strategists are convinced that Italy’s new government will continue austerity measures that preserved the currency union during the region’s sovereign crisis even as the euro tumbles from a 14-month high.
Analysts raised their second-quarter forecasts for the 17- nation currency to $1.32 from $1.28 at the end of December as Italy’s Feb. 24-25 election ended in a four-way tie, according to the median of more than 60 estimates in a Bloomberg survey. That 3.1 percent upgrade is the second-biggest among the Group of 10 currencies after the Swedish krona.
While traders pushed the euro down to $1.3046 yesterday in New York from this year’s high $1.3711 on Feb. 1 as anti- austerity parties led by three-time premier Silvio Berlusconi and former comedian Beppe Grillo won blocking minorities in the Senate, currency strategists are looking to the debt markets. Italy’s borrowing costs have fallen from a three-month high on Feb. 27 as European Central Bank President Mario Draghi said his untapped bond-buying program, known as Outright Monetary Transactions, remains in place as an “effective” backstop.
“What OMT has done in my view is put the destiny of each country in their own hands rather than to be hostages to external factors,” Nick Verdi, a strategist at Barclays Plc in Singapore, said yesterday. “So it is essentially Italy’s choice as to what happens next. And that’s why you haven’t seen an aggressive sell-off in the euro.”
Barclays’ second-quarter forecast is $1.35, up from an estimate of $1.25 at the end of 2012, according to data compiled by Bloomberg. “Ultimately, the market still thinks that we will get some form of political resolution in Italy,” Verdi said.
While Europe’s common currency sank 3.8 percent in February against the dollar, its first slide in seven months, it’s up from a two-year low of $1.2043 on July 24. That was just days before Draghi pledged to do whatever it takes to preserve the currency union, kick-starting a 14 percent rally to $1.3711.
Democratic Party chief Pier Luigi Bersani, whose coalition won the most votes in Italy’s election, said on March 3 that he will form a government without seeking an alliance with Berlusconi or Grillo. If no political leader gathers enough support in parliament to become prime minister, President Giorgio Napolitano can call early elections.
Grillo, whose Five-Star Movement won 25 percent of the vote in last month’s Italian elections, said he would quit politics if his party members support a government led by Bersani’s Democratic Party. “If there were a confidence vote by the parliamentary group of the Five-Star Movement in favor of the ones that have destroyed Italy, I would retire from politics,” Grillo said yesterday in a post on Twitter.
While Italy has the third-highest ratio of debt to gross domestic product among developed countries at 126 percent, the government budget will turn to surplus this year for the first time since at least 1988, according to estimates from the International Monetary Fund that exclude extraordinary items.
Views on Italy’s election are divided among ratings companies. Standard & Poor’s retained its BBB+ rating on the country’s debt on Feb. 26, citing expectations that Italy’s fiscal consolidation wouldn’t deviate from its current path. Moody’s Investors Service said the election impasse puts Italy at risk for a downgrade. Fitch Ratings lowered Italy on March 8 to BBB+, the third-lowest investment-grade, from A-.
Italy’s 10-year bond yield fell to 4.64 percent last week after touching 4.96 percent on Feb. 27, the highest since November. When Berlusconi resigned in November 2011, the yields climbed above the 7 percent level that forced Greece, Portugal and Ireland to seek international bailouts.
The cost to insure the nation’s government bonds from non- payment for five years with credit-default swaps decreased to 259.92 basis points last week from this year’s high of 291.52 on Feb. 26. That’s the third-highest among sovereigns globally after Greece and Portugal, and more than seven times the 39.01 cost for similar contracts tied to U.S. government debt.
“The market has become less sensitive to Italy’s political turmoil as this go-go market atmosphere overrides negative catalysts,” Shinji Kunibe, the chief portfolio manager for fixed-income investments in Tokyo at Nissay Asset Management Corp., which manages the equivalent of $53 billion. said yesterday. Even so, “a receding of austerity will make the OMT become like a pie in the sky for Italy,” he said.
Italy’s bonds have been supported along with global equity markets as central banks in the U.S., Japan and the U.K. pumped cash into their economies while the OMT program, under which the ECB buys government debt in exchange for austerity pledges, has kept the borrowing costs anchored.
Futures traders are signaling doubts that the euro can hold onto its gains. Wagers on a decline outnumbered those on a gain by 26,116 contracts on March 5, the most so-called net shorts this year, figures from the Washington-based Commodity Futures Trading Commission show. That’s a reversal from net longs of 37,952 on Feb. 5, a level unseen since July 2011.
The currency bloc’s economy will shrink 0.3 percent in 2013, marking its first annual back-to-back contraction since the euro’s birth in 1999, the European Commission forecast in February. Data this month showed unemployment in the region rose to a record 11.9 percent in January.
Premiums paid by traders for the right to sell the euro over those to buy it climbed to 1.7325 percentage points on Feb. 26, the highest since August. The three-month risk reversal rate dropped 1.2375 percentage points in February, the biggest monthly slide since November 2010, when Ireland was forced to seek an international bailout.
“We have to look into Europe’s fundamentals rather than Italian politics,” Daisuke Karakama, a market economist in Tokyo at Mizuho Corporate Bank Ltd, said yesterday. “The high unemployment is a big problem. Investors are more inclined to let go of the euro, and that’s crystal clear looking at the drop in risk-reversal rate.”
The shared currency is still higher than the average of $1.2125 since its inception. Analysts forecast the currency will end this year at $1.30. UBS AG strategists said in a March 9 report that it favors buying the euro versus the pound, Swiss franc and yen. Goldman Sachs Group Inc. said a day earlier it expects a stronger euro.
Draghi told reporters on March 7 that in Italy “the ball is in the government’s hand,” and the OMT remains in place as an effective backstop. European Union leaders, including EU Economic and Monetary Commissioner Olli Rehn and German Foreign Minister Guido Westerwelle, have said that government stability in Italy is crucial for the region.
“We need a much clearer indication of who the next Italian government will be and what their plans are on fiscal policy,” Sean Callow, a senior currency strategist at Westpac Banking Corp. in Sydney, said in a phone interview on March 8. “The Italian situation looks like it’s going to drag on for some time -- there is a complacency that it will all work out.”
--Editors: Naoto Hosoda, Robert Burgess