Italy concerns start to spook markets

The prospect of an adverse outcome from Italy’s constitutional referendum on Sunday has rattled global trading at the start of this week. European stocks are down across the board, with the FTSE MIB in Italy leading the way, falling nearly 2% on Monday. The futures markets are predicting a further decline in European stocks today, interestingly, the Dax could come under more pressure than the FTSE MIB.

What a No vote in Italy could look like

Monday’s trading action offered us a glimpse into what to expect if Italian PM Matteo Renzi loses the referendum on Sunday.  Basically, it is bad news for risk appetite and for global financial stocks, in particular. Italy’s Unicredit had the biggest fall, down more than 4%, while Deutsche Bank fell nearly 2%. US banks were also in the firing line, with the S&P financial sector dropping 1.3%.  While the FTSE 100 did not fare as bad as its European counterparts, its financial sector did come under pressure, with declines for all the major UK banks. The outcome of this referendum poses key risks for the FTSE 100, not only because the index is trading at a sky-high P/E ratio, but also because it has a large financial sector that is closely entwined with Europe.

Why decision time for Italy could impact global volatility

A no vote on Sunday is a major event risk for the European financial sector. Up to 8 Italian banks could fail, as Matteo Renzi’s bank bailout programme is likely to be scrapped if he resigns. It is not known what would replace it, or if the European authorities would step in to save the Italian financial system. If not, then the creditworthiness of some of the larger more systemic banks, such as Deutsche Bank, could be at risk. DB has plenty of risks of its own, if the European authorities don’t save Italy’s banking sector, then how could it justify saving Germany’s largest bank? Thus, we could see further declines in DB’s stock price before the week is out.

No second financial crisis, but worth watching

While we don’t think that the fallout will be as severe as the financial crisis, the interconnectedness of the global financial system means that a crisis point for banks in Italy could impact financial centres around the world, so expect some severe market volatility if Italy votes no next weekend.

Since Italy has not allowed polling since November 18^th, the markets are going into this election blind. This is likely to increase the tension and nervousness around this referendum, and could keep market volatility high for the rest of this week. The Vix, Wall Street’s fear gauge, started to rise on Monday, and we could see further advances in volatility in the coming days, putting pressure on stocks and causing safe havens like the yen and US Treasuries to rally.

The ECB gets ready to extend stimulus

Elsewhere, President Draghi was speaking at the European Parliament on Monday, he said that the Bank will do all it can to keep policy accommodative enough to boost inflation. Thus, the Bank may announce an extension of its QE programme as early as next week’s ECB meeting. This is likely to keep a cap on euro upside for the rest of this week; EURUSD could not manage to break above 1.0680 on Monday, which is now key resistance.

Oil on the rise as the Opec meeting nears

Watch the oil price on Tuesday, after news that Russian President Putin is putting pressure on Iran to agree to a production cut ahead of Wednesday’s Opec meeting. This is significant; if Iran agrees to cut its oil production then it is more likely that Saudi will also agree to the cut, even though Saudi is said to be wavering, with only one day t go before the meeting. Oil is lower on Tuesday, but is at serious risk of news flow. Any signs that a production cut is coming could see a major rally. The next major resistance level in Brent crude is $50 per barrel.