We have consistently argued that many market participants are repeating the mistakes of 2010-2011 when they thought Greece would leave the monetary union either on its own accord or as a result of it being pushed out. Again now, the political commitment to the project has been underestimated.
We also argue that the frustration expressed by Greek voters in turning to Syriza is not an isolated case. Most of the opposition to austerity and the EU have come from the political right. In the recent past, a threat from the populist right would bring together the center-left and center-right to resist. However, we note that in the recent by-election in France, UMP leader Sarkozy did not urge a vote for the Socialist candidate over the National Front candidate after the UMP candidate failed to make it to the run-off. Sarkozy’s rival within the UMP, Juppe did encourage a united front to defeat the National Front candidate. In the end the Socialist won, but strong showing of the National Front was an emboldening moral victory.
We have noted the changing political climate in Italy. Prime Minister Renzi is in a stronger position after the election of his presidential candidate. The alienation of Berlusconi has also helped to solidify Renzi’s left flank, and appears to have won over some centrists. His reform drive still appears to be on track, though the next week or so will be important to confirm this.
Spain, which clearly has a stronger economy than Italy, has a less supportive political climate. The Syriza-like party Podemos appears to be enjoying growing support. There is a national election later this year. Next month, there is a regional election in Andalusia. The Socialists govern it now. It is ahead of other center-right PP 35.2% to 29.1%. Podemos is tracking almost 15%. This could put it into the regional government, unless it takes a page from Italy’s 5-Star Movement and refuse to be part of a coalition.
In any event, political, rather than economic considerations can see Italian assets outperform Spain. As this Great Graphic (composed on Bloomberg) shows, Italian 10-year bond yields are set to fall below Spain’s. This week, Italy’s 10-year bond yield has fallen 9 bp to Spain’s 6. Over the past month, Italy’s yield has fallen 24 bp, while the comparable Spanish yield has fallen by 13 bp. At the same time, the market anticipates the start of the ECB’s sovereign bond buying program next month. Given the capital key (essentially the size of the economy in EMU) basis for the bond purchases, more Italian bonds will be bought than Spanish bonds. Although there may have been some short-lived moves, since August 2013, Spanish 10-year yields have been below Italian yields. This is set to change.