Yields rise as risk appetite returns. Equity markets also recover sharply. But US-China trade tensions spike again

By Nick Smyth

Pressures on the Italian bond market eased overnight, with the 2 year Italian yield falling over 100bps.  There have been reports that the League and Five Star might have another attempt at forming a government (presumably with a more mainstream choice of finance minister) while Five Star leader Di Maio has made some more reassuring comments.

There has been a broad-based unwind of yesterday’s flight to safety moves, with equities higher, core bond yields higher and the EUR stronger.  Against a backdrop of a stronger EUR and improving risk appetite, the NZD has risen close to 0.70. 

The major news overnight is that pressures on the Italian bond market have eased.  The 2 year Italian yield fell just over 100bps on the day, reversing more than half of the incredible move higher from Tuesday night.  There have been reports that the Italian President will allow Five Star and the League to have another attempt to form a government, with Five Star leader Di Maio saying he was willing to propose a choice of new finance minister.  The League, which has seen large gains in opinion polls since the election, seems more intent on going back to new elections, but the discussions are reportedly ongoing.  Some of the hostile rhetoric has also been toned down over the past 24 hours, with Five Star leader Di Maio saying the two anti-establishment parties never sought an exit from the euro and that Five Star was willing to cooperate with the President.  The political situation remains fluid and could yet turn again, but the recovery in the Italian market overnight was certainly a welcome sign.  The decline in Italian yields over the session was reinforced by a successful auction of €5.6b Italian government bonds (with demand and pricing reasonably solid given the circumstances).  

The easing tension in Italy has seen a broad-based unwind of the flight to quality moves seen yesterday.  The German 2 and 10 year yields are up more than 10bps, helped at the margin by a stronger than expected German CPI release and a surprise decline in the German unemployment rate.  The US 10 year Treasury yield is around 2.85%, some 10bps off the lows reached around this time yesterday.  Locally, after being marked almost 10bps lower in yield on the open, NZ government bond yields spent most of the remainder of the session grinding higher.  NZ government bond yields ended the day only 1-2bps lower than the previous day’s close. 

Equity markets have also recovered sharply.  The S&P500 is up 1.3% on the day, more than reversing yesterday’s 1% fall, and close to two month highs.  Financials and energy stocks led the way higher, the latter boosted by a 3% rise in crude oil prices overnight.  In Europe, the Italian bourse is more than 2% higher. 

The more positive sentiment towards Italy has overshadowed some ratcheting up in trade tensions between US and China, following President Trump’s decision earlier this week to go ahead with $50b in tariffs on Chinese imports.  A Chinese foreign ministry spokeswoman said overnight that China would respond accordingly.  Commerce Secretary Wilbur Ross is due to visit China this weekend to continue the negotiations. 

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