Post-election Italy is a debacle. European markets showed clear signs of unrest as they plunged yesterday. Italy's stock market fell 5% and the Ibex closed the day with 3.2% losses, losing support at 8,000 points The rest of the European markets were also in the red for the day.
As a new stage of volatility begins, risk premiums for Spain (392 basis points) and Italy (345 basis points) shot up. Tensions were high for Italy in particular, and the spread between them extended to 47 basis points. Bernanke has announced that he will maintain the United States's QE3 stimulus program as long as unemployment stays at or above 6.5%, which kept the Dow Jones from collapsing. It rebounded slightly to close up by 115 points. The United States is trying to distance itself from Europe, which makes sense for the global superpower. Signs of recovery are starting to show in the US while Europe continues to look for a way to end its recession and to avoid further political and economic crises. Still, the US could face trouble ahead. Democracts and Republicans need to come to an agreement that avoids the fiscal cliff by March 1 after being given extra time to debate the issue. This was one of the reasons, in addition to disappointing developments in Europe, that markets reacted to fears of returned volatility. But the political crisis in Italy ignited more volatility in the region and the near-term view is much worse than previously forecasted. In the next few days, tensions will continue and could even escalate if Italy does not figure out a way to stabilize its government.
The leftist coalition led by Pier Luigi Bersani won the elections, but with such a small margen to Berlusconi that it will be difficult for the victor party to execute any of its programs. Bersani can't count on backing from Mario Monti, who was the darling of both Merkel and the markets. For the EU, which always sided with Monti, the worst evil would be a shared government between Bersani and Berlusconi and their respective political parties similar to the coalition between the Social Democrats and Democratic Christians in Germany. But in Italy, a union like this is hard to imagine, and both sides are being pressured to resist it. Bersani called on the leader of the 5 Star Movement yesterday, asking him, "What do you want to do with this country"
Even though the focus is on Italy, Spain and the rest of the euro zone cannot afford to overlook their precarious state. Unemployment, deficits, national debts and corruption are threatening the region's future. Instability in Italy will slow down recovery for Europe in the best case scenario, and in the worst it will prolong a recession by draining confidence from consumers, companies and the markets. The instability will also affect Italy's neighbors. Spain, for example, could start thinking about a bailout again and calls into question the EU's mechanisms for tying up some complex economic situations. The EU should not keep staring implacably at the drama unfolding in the South of Europe. The European Commission should come up with solutions that gaurantee stability and let the member states know that they need to meet strict requirements, not focus too much on election results and not look to political Messiahs for the answer.
