Risk-averse investors moved to the perceived safety of the U.S. currency.
The euro EURUSD -2.02% fell to $1.3553, down from $1.3836 in North American trading late Tuesday. It’s only the fourth time this year the shared currency has fallen 2% or more.
The dollar index DXY +1.57% , which tracks the U.S. unit against a basket of six major currencies, rose to 77.885 from 76.620 on Tuesday.
The yield on Italy’s benchmark 10-year government bond IT:10YR_ITA -0.66% rose as high as 7.44%, according to FactSet Research data, then eased off to 7.25% in afternoon trading. The spike followed a decision by LCH.Clearnet to raise margin requirements on Italian debt. See story on Italy’s bonds, margin hike.
“Italian 10-year yields moved above 7% and excessive market volatility triggered circuit breakers in the futures market as increased uncertainty over the political situation in Italy led to widespread risk aversion,” said Chris Walker, strategist at UBS.
On Tuesday, the euro received a lift after Silvio Berlusconi promised to step down as Italy’s prime minister pending parliamentary approval of new austerity measures and structural reforms. Read about euro, Berlusconi resigning.
Now the question is what kind of government fills his place, and whether it tackles the politically-sensitive pension and labor rules in a way that restores confidence in Italy, said strategists at Brown Brothers Harriman.
“The most likely scenario, in the coming weeks, is that the current coalition rally around another prime minister candidate that it feels can gain domestic and international confidence,” said Marc Chandler, global head of currency strategist at the firm.
The second most likely scenario is the formation of a “technocratic” government, which may be more effective at implementing economic reforms quickly, he said.
“This is likely the most market-friendly outcome,” Chandler said.
The alternative would involve early elections and “be the worst outcome for sentiment as it would increase uncertainty and of course stall progress on economic reform,” he said.
European equities tumbled and U.S. stocks dropped, with the Standard & Poor’s 500 index SPX -3.68% down 3.6%. Still, some investors said the reaction was likely overdone.
“With a new Italian government to come in [once austerity measures are in place] and a unity government on the way in Greece, forward-looking names will probably be buying [euros] on the $1.36 handle, maintaining a range-trading environment for the euro-dollar,” said Sebastien Galy, strategist at Societe Generale. “The wave of fear should travel through in the U.S., before some sense comes back to the market and we see some relative normality.”
Also Wednesday, the British pound GBPUSD -1.03% changed hands at $1.5926, down from $1.6115 Tuesday. The Bank of England is expected to leave monetary policy unchanged Thursday, but may further boost its bond-buying program as soon as next month, analysts said. Read story about Bank of England meeting.
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