Italy is Upsetting the Apple Cart Again

Investors are feeling a sense of 2012 all over again in response to the Italian election results over the weekend. The prospect of anti-euro, populist parties influencing an Italian policy shift away from the eurozone has been upsetting the bond market. The Italian 10-year sovereign bond yield spiked from 1.8 per cent to more than 3 per cent over the last four weeks, reflecting the fragility of the situation.

Europe has been on an economic growth path, albeit short of analysts’ expectations. The eurozone economy expanded 2.5 per cent year-over-year in Q1/2018, off slightly from Q4/2017 but on a steady 5-year recovery trajectory. Retail sales grew by 0.8% over the last 12 months, trailing the US, Japan and the UK. However, economic conditions appeared healthy enough to warrant the European Central Bank to announce plans to curtail their quantitative easing program later this year.

Italy’s election revelation not only exposes the vulnerability of the eurozone economy, but the flawed construction of the eurozone itself. As we learned in 2012, monetary union without fiscal unification is perpetually threatened by the conflicting political whims of disparate sovereigns, putting continual pressure on the common currency, the euro. A functioning eurozone is characterized by bond constituent yields moving in tandem and, for most of the last 10 years, this has been the case. We have seen but two exceptions: 2012, and today.