Why did political turmoil in Italy spark a selloff in markets?

On a special podcast edition of Market Week in Review, Senior Investment Strategist Paul Eitelman and Rob Cittadini, director, Americas institutional, discussed the market impact of the recent political crisis in Italy.

Threat of new elections in Italy jolts markets before coalition government approved

The Italian political crisis whipsawed markets the week of May 28, Eitelman said, beginning with President Sergio Mattarella’s refusal to accept the finance minister nominated by a proposed coalition government of the 5-Star Movement and League parties. With this refusal, the proposed new government appeared on the verge of collapse—putting Italy on the cusp of moving toward new elections later this year, Eitelman said. This led to pretty significant damage to financial markets the following day, he noted:  2-year Italian government bond yields spiked from around 0.5% on May 28 to roughly 2.5% on May 29, with global equity markets also taking a hit. Why?

“What markets were extracting from this was the risk that, in a new Italian election, a populist coalition could garner even more power and, through that, endanger Italy’s membership in the eurozone,” he explained. The implications of a Quitaly scenario—in other words, an Italian exit from the eurozone—would be significant for European banks and the European economy at large, given that Italy is the third-largest economy in the eurozone, Eitelman said.

Fortunately, it appears that cooler heads may be prevailing, he said, as a new League / 5-Star Movement coalition government—with a different finance minister—was officially approved by President Mattarella on June 1. This means that, from an investment strategy perspective, the political risks in Italy have probably eased somewhat, Eitelman said—noting that due to the recent selloff, Italian assets are now trading at more attractive valuations.

The Trump administration and tariffs—A negotiating tactic?

Shifting to trade, Eitelman noted that the recent imposition of tariffs by the U.S. on steel and aluminum imports from Canada, Mexico and the European Union (EU) has made for a ping-pong ball situation for many global investors. “There’s been a lot of back and forth since the administration of U.S. President Donald Trump first announced plans for tariffs in March,” he said, explaining that the countries now subject to these tariffs were originally given exemptions. In addition, there’s been a lot of mixed signals in regards to how the trade dispute between the U.S. and China will play out, he added.

Looking through all of this, Eitelman and the team of Russell Investments strategists’ view is that the Trump administration is using the threat or imposition of tariffs as a negotiating tactic in order to strike better trade deals with Canada, Mexico, China and the EU. “If we’re correct in our assessment, then we believe that we’ll likely avoid a full-blown trade war,” he stated—“but this is certainly a situation to keep monitoring closely.”

Glowing U.S. jobs report points to robust labor market

The U.S. employment report for May, unveiled Friday by the Labor Department, showed that the nation’s labor market is really booming, Eitelman said. The country added 223,000 jobs in May, while the unemployment rate dropped to 3.8%—the lowest in 18 years, he noted. From Eitelman’s standpoint, this makes for the strongest labor market the U.S. has experienced since the late 1990s.

So, how might another impressive jobs report impact the U.S. Federal Reserve (the Fed)’s plans for interest rate increases the rest of the year? “At Russell Investments, we’re of the view that the Fed will have to continue with its rate-hiking cycle,” he said—“and we think it’s very likely the central bank will raise rates again at its June 13 meeting.” Eitelman added that he and the team of strategists still think it’s a bit of a tossup as to whether the Fed hikes three or four times total in 2018—but that four is not unreasonable should the nation’s economic indicators continue trending in the right direction.

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