Italy: At last!

After protracted squabbling, the Five Star Movement (M5S) and the League have now agreed on the formation of a government in Italy, with President Mattarella having approved the appointments. The Prime Minister-designate is former university professor Giuseppe Conte, who declared the attempt to form a government as having failed as recently as last Sunday. The other key posts: Giovanni Tria, a supporter of the flat tax, is set to become Finance Minister, Paolo Savona is to be Minister for Europe, and party heads Salvini (League) and Di Maio (M5S) will become Minister for the Interior and Minister for Economic Development respectively. While many of these appointments will be greeted with scepticism both in Europe and in the markets, the appointment of Enzo Moavero Milanesi – who served as Minister for Europe in the Letta government until 2014 – as Foreign Minister will bring some sort of relief.

Although the negotiations were drawn-out, with a number of unexpected twists, the process of forming a government is now likely to be concluded very rapidly. Indeed, Conte is expected to be sworn in as early as 4 p.m. today, and the new government must then be submitted to parliament for a vote of confidence within 10 days. Given the majority enjoyed by M5S and the League, however, this approval should be a formality. Prime Minister Conte will then make his first important appearance on the European stage at the meeting of heads of state and government on June 28 and 29.

With yields of Italian government bonds having strongly risen on Monday and Tuesday, above all with regard to short-dated bonds, a market consolidation has been evident since Wednesday. This morning yields were also falling across the board in early trading. On the one hand, the market is viewing the removal of uncertainty over the Italian government as a positive, while on the other, market interventions to correct the extreme swing were probably also a factor. The Italian Treasury bought back EUR 0.5 billion of short-dated government bonds at the start of the week alone. Furthermore, comments by Chancellor Merkel, who expressed her willingness to enter into dialogue with Rome, were also viewed as good news. However, the current recovery is likely to prove no more than a snapshot of a particular moment. Many investors are greatly unsettled by factors such as the political outlook, the risk of rating downgrades, and the turbulence of markets in recent days, and are likely to scale down their exposure to Italy further over the next few weeks. An enduring narrowing of spreads is therefore unlikely to occur. Quite the opposite: If the government pursues a course of confrontation with Brussels together with a policy of fiscal expansionism, further waves of rising yields are a very real threat.

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