ANALYST ON ITALY: 'This Could Become A Major Problem...'

Citi’s currency guru Steven Englander weighs in on what we just saw in Italy.

This is the first European election in which voters didn’t do the right thing. Instead they gave surprising support to politicians who reject austerity and, in some cases, the euro. This could become a major problem if it proves contagious. The feel-good from the runup in Italian asset markets was not enough to offset the feel-bad from austerity, low growth and unemployment. If all it would take to fix this was an ECB rate cut, they would do so immediately, but euro zone politicians may need to ease fiscal constraints¬† and find ways to quickly stimulate growth. Elections are more problematic than market scares or sentiment shifts as they can’t be undone by printing money. Still the outcome does not seem so dire that a bit of growth and ECB flexibility could not turn it around.

Meanwhile, SocGen currency analyst Sebastien Galy titles his note: “Instability Cubed.”

He writes:

EUR crosses came under pressure as Italian polls suggest a split vote with each chamber held potentially by a different party, whereas laws need to be approved by both chambers. Rising FX volatility has not yet mutated into a full blown correction, though the correction is deep. USD/JPY remains a buy on the 90 handle and EUR/USD should hopefully hold above 1.30. Nonetheless, gyrations in FX and now in equities are increasingly severe. Such tendency for sharp corrections seen as opportunities to buy on dips are similar to the market behaviour in 2007 as we advanced every deeper into the subprime crisis. The next key test will be the sequester decision in the US which does not seem to be going in an encouraging correction.

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