Italy's asset markets has been roiled by budget worries in the past two months
The FTSE MIB suffered a 2.4% loss in yesterday's trading and that sees it fall to the lowest level since April 2017. Ironically, since a 2.4% budget deficit target was set out by Italy's new government, investors have not been taking too kindly with the rhetoric being presented.
Sure, there have been a few calming details but they haven't amounted to anything significant and although the government has been playing down concerns of leaving the euro, actions speak louder than words.
And sure enough, investors have been smart to pick up on that. Yesterday, Italy's 10-year bond yields jumped up to their highest levels since early 2014:
If that doesn't signify concerns for lawmakers and the ECB, then I'm not sure what does. But now the big question will be "is this move overdone"?
There are only two details you need to know as we look to assess Italy's budget and they're pretty much almost one in the same. The first being the reception of the proposal by the EU. Should it be rejected, expect a continued backlash between Italy's government and European leaders to take place and that will further weigh on Italian assets and the euro.
The second detail is one that we will have to wait on until the end of the month and that is the rating agencies' reviews on Italian credit. A downgrade looks imminent at this point and no doubt that markets are pricing in some of that action already now. But even when the news hit, I would expect a knee-jerk reaction from investors to sell Italian assets as well as the euro.
In short, the most likely scenario presents a case that there is still further pain to be had for Italy. But on the flip side, should the EU come to an agreement with Italy on the budget, expect a lot of these downside risks to fade in the immediate reaction.
However, that doesn't mean that they will totally be gone. Rating agencies may very well act upon the EU's decision to the budget proposal so that's what is going to be the driving factor for the time being. But at the end of the day, the proposal is just a target.
If Italy's fiscal plans don't play along, the debt issue is going to be one that will cast a dark cloud on Italian assets as well as the euro for many, many more months to come. Italy's previous government promised the EU that they will stick to a 1.6% deficit in 2018 but the new government's latest revision says they will go with a 1.8% deficit this year (granted growth has been sluggish).
Hence, finding common ground of a 2.0%, 2.2%, or 2.4% budget deficit target means little at the end of the day if the government already decided that they won't stick to it (or present unrealistic growth assumptions to mask that fact). And that's the daunting prospect that Italian investors and the euro has to worry about moving forward.
