ANZ Morning Brief: Time for reflection

GLOBAL MARKETS:  Our London colleagues report that it was a quiet day in Europe . Most of the day’s focus was on the negative Italian headlines.  The weekend’s Italian political bombshell, along with some very weak industrial production data out of France and Italy , weighed on European equities, EUR and Italian sovereign bonds in early trading. However, most markets have made a small recovery since the US open, with European equities (except Italy ’s) largely unchanged on the day, and EUR higher. Peripheral bond spreads remain wider, led by Italian 10yr bonds, which are up about 30bps. The latest headlines from current Italian Prime Minister, Mario Monti, are that he isn’t considering standing as a candidate in the upcoming elections.  Bloomberg notes that the election could be held as soon as February, with Monti vowing to resign after attempting to gain parliamentary support for the 2013 budget. Speaking at a press conference in Oslo (where he and other European leaders are collecting their collectively won Nobel Peace Prize), he said markets “shouldn’t fear any decision-making void” upon his departure. Call me a pessimist, but if you have to say it, you know there’s a problem!

KEY THEMES AND VIEWS

Time for Reflection? Although the overnight session was fairly quiet, there was actually quite a bit going on. But what do we make of it all? It’s certainly too soon to declare that Europe might be plunged back into crisis, but by the same token we don’t like what we see in Italy, which is no bit-player, and as such we’ll be watching the situation closely. Italy is basically living on the grace and favour of low yields, but if bond yields start to back up too far things could get nasty (the OECD puts Italian net public debt at 98.6% of GDP).  Italy typically struggles to maintain a surplus (even if it can turn a primary surplus), and with growth sideways at best and interest payments in 2013 of 5.0% of GDP, this economy needs either growth or low yields. All of this is, of course, old hat and simple maths. However, the point is, if the market should lose confidence in Italy, there’s no easy fix as there was for Greece, courtesy of it’s sheer size as the 8^th largest economy in the world. With the US fiscal cliff looming, the question for NZ has to be, what is the risk for us? It has not affected us so far, and in fact the NZD is pretty well back at the year’s high again. NZGS still offer “best in class” expected returns with low volatility, but is that enough? It probably is as long as the wheels don’t fall off completely, in Europe or the US , but things could get challenging if the situation intensifies significantly.