Even Berlusconi Can’t Slow Bulls Boosting Euro View: Currencies

Foreign-exchange strategists are convinced that Italy’s new government will maintain austerity measures that preserved the currency union during the region’s sovereign crisis even as the euro tumbles from a 14-month high.

Analysts raised their second-quarter forecasts for the 17- nation currency to $1.32 from $1.28 at the end of December as Italy’s Feb. 24-25 election ended without a clear winner, according to the median of more than 60 estimates in a Bloomberg News survey. That 3.1 percent increase is the second-biggest among the Group of 10 currencies after the Swedish krona.

While traders pushed the euro down to $1.3018 today from this year’s high $1.3711 on Feb. 1 as anti-austerity parties led by three-time premier Silvio Berlusconi and former comedian Beppe Grillo won blocking minorities in the Senate, strategists are looking to the debt markets. Italy’s borrowing costs have fallen from a three-month high on Feb. 27 as European Central Bank President Mario Draghi said his untapped bond-buying program, known as Outright Monetary Transactions, remains in place as an “effective” backstop.

“What OMT has done in my view is put the destiny of each country in their own hands rather than to be hostages to external factors,” Nick Verdi, a strategist at Barclays Plc in Singapore, said yesterday. “So it is essentially Italy’s choice as to what happens next. And that’s why you haven’t seen an aggressive sell-off in the euro.”

Seeking Resolution

Barclays’s second-quarter forecast for the euro is $1.35, up from an estimate of $1.25 at the end of 2012, according to data compiled by Bloomberg. “Ultimately, the market still thinks that we will get some form of political resolution in Italy,” Verdi said.

While Europe’s common currency slumped 3.8 percent in February against the dollar, its first decline in seven months, it’s up from a two-year low of $1.2043 on July 24. That was just days before Draghi pledged to do whatever it takes to preserve the currency union, kick-starting a 14 percent rally to $1.3711.

Democratic Party chief Pier Luigi Bersani, whose coalition won the most votes in Italy’s election, said on March 3 he will form a government without seeking an alliance with Berlusconi or Grillo. If no political leader gathers enough support in parliament to become prime minister, President Giorgio Napolitano can call early elections.

Budget Surplus

Grillo, whose Five Star Movement won 25 percent of the vote in last month’s Italian elections, said he would quit politics if his party members support a government led by Bersani’s Democratic Party. “If there were a confidence vote by the parliamentary group of the Five Star Movement in favor of the ones that have destroyed Italy, I would retire from politics,” Grillo said yesterday in a post on Twitter.

While Italy has the third-highest ratio of debt to gross domestic product among developed countries at 126 percent, the budget will turn to surplus this year for the first time since at least 1988, according to estimates from the International Monetary Fund that exclude extraordinary items.

Views on Italy’s election are divided among ratings companies. Standard & Poor’s retained its BBB+ ranking on the country’s debt on Feb. 26, citing expectations that fiscal consolidation wouldn’t deviate from its current path. Moody’s Investors Service said the election impasse puts Italy at risk for a downgrade. Fitch Ratings lowered the nation’s rating on March 8 to BBB+, the third-lowest investment-grade, from A-.

Falling Yields

Italy’s 10-year bond yield fell to 4.60 percent today after jumping to 4.96 percent on Feb. 27, the highest since November. When Berlusconi resigned in November 2011, the yield climbed above the 7 percent level that forced Greece, Portugal and Ireland to seek international bailouts.

The cost to insure the nation’s government bonds from non- payment for five years with credit-default swaps decreased to 264.165 basis points yesterday from this year’s high of 291.52 on Feb. 26. That’s the third-highest after Greece and Portugal among sovereigns of developed economies, and more than seven times the 39.83 cost for similar contracts tied to U.S. government debt.

“The market has become less sensitive to Italy’s political turmoil as this go-go market atmosphere overrides negative catalysts,” Shinji Kunibe, who helps oversee the equivalent of $53 billion as chief portfolio manager for fixed-income investments at Nissay Asset Management Corp. in Tokyo, said yesterday. Even so, “a receding of austerity will make the OMT become like a pie in the sky for Italy,” he said.

Short Positions

Italy’s bonds have been supported along with global equity markets as central banks in the U.S., Japan and the U.K. pumped cash into their economies, while the OMT program, under which the ECB buys government debt in exchange for austerity pledges, has kept borrowing costs anchored.

Futures traders are signaling doubts the euro will hold onto its gains. Wagers on a decline outnumbered those on a gain by 26,116 contracts on March 5, the most so-called net shorts this year, figures from the Washington-based Commodity Futures Trading Commission show. That’s a reversal from net longs of 37,952 on Feb. 5, a level unseen since July 2011.

The region’s economy will shrink 0.3 percent in 2013, marking its first annual back-to-back contraction since the euro was introduced in 1999, the European Commission forecast in February. Data this month showed unemployment rose to a record 11.9 percent in January.

Risk Reversals

The premium paid by traders for the right to sell the euro over those to buy it climbed to 1.7325 percentage points on Feb. 26, the highest since August. The three-month risk reversal rate dropped 1.2375 percentage points in February, the biggest monthly slide since November 2010, when Ireland sought an international bailout.

“We have to look into Europe’s fundamentals rather than Italian politics,” Daisuke Karakama, a market economist in Tokyo at Mizuho Corporate Bank Ltd, said yesterday. “The high unemployment is a big problem. Investors are more inclined to let go of the euro, and that’s crystal clear looking at the drop in risk-reversal rate.”

The shared currency is still higher than the average of $1.2125 since its inception. Analysts forecast the currency will end this year at $1.30. UBS AG strategists said in a March 9 report that it favors buying the euro versus the pound, Swiss franc and yen. Goldman Sachs Group Inc. said a day earlier it expects the euro to strengthen.

Draghi told reporters on March 7 that in Italy, “the ball is in the government’s hand” and the OMT remains in place as an effective backstop. European Union leaders, including Economic and Monetary Commissioner Olli Rehn and German Foreign Minister Guido Westerwelle, have said government stability in Italy is crucial for the region.

“We need a much clearer indication of who the next Italian government will be and what their plans are on fiscal policy,” Sean Callow, a senior currency strategist at Westpac Banking Corp. in Sydney, said on March 8. “The Italian situation looks like it’s going to drag on for some time. There is a complacency that it will all work out.”

To contact the reporters on this story: Mariko Ishikawa in Tokyo at mishikawa9@bloomberg.net; Masaki Kondo in Singapore at mkondo3@bloomberg.net; Hiroko Komiya in Tokyo at hkomiya1@bloomberg.net

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net

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