Funda-FX wrap: threat of snap elections in Italy ease, but more volatility to come

• Funda-FX today was yet again animated, but this time it spun the markets back on to its feet.
• Markets reversed higher in a relief rally after headlines from Italian news indicated a desire to avoid a snap election in coming months.
• Yesterday's Funda-FX Wrap: Italy is spreading a virus throughout global markets.

The PM-designate, Carlo Cottarelli, former IMF economist, selected after the failure of populist parties to get their cabinet approved said that discussions to form an interim government have been moving ahead. 

Cottarelli added:

"This circumstance, also considering market tensions, has compelled me to wait for further developments."

Italy’s Di Maio of The 5 Star Movement had said earlier that they had never sought a euro exit and are willing to propose a new Finance Minister. 
This gave further rise to money flows back into Italy and nations that are on the brink of similar political disarray. 

“Let’s find someone of the same caliber as Savona, who would still remain in the government in another ministry,” 5-Star chief Luigi Di Maio said on Facebook after meeting with President Sergio Mattarella. “If the League agrees ... we can still form a government.”

However, so far, the League has refused to take part in any government that did not have Savona as economy minister. Meanwhile, more volatility can be expected in coming months as domestic and foreign actors in the Italian saga make their decisions.

In any case, Italy’s 2yr government bond yield fell 123bp to 1.60%, partly retracing the previous day’s 193bp rise. The 10yr Italian bond yield fell 29bp and Portugal’s by 13bp, while German bunds lost some safe-haven demand, the 10yr yield rising 11bp. Italian stocks rose 2.1% but overall the US equity bounce exceeded Europe’s - noted analysts at Westpac.

MEanwhile, analysts at Wells Fargo explained, “Decisions that are made by political leaders in other European countries and by authorities at the ESM and the ECB will also play a role in the ultimate outcome of the current situation in Italy. To repeat, it is too early to make confident predictions about how the situation in Italy will ultimately evolve, but readers should be prepared for more volatility in the coming months as the actors in the Italian saga make their decisions.”

Elsewhere, the major European bourses had also made a partial comeback compared to yesterday's downturn:

• Spain's IBEX rose 0.7%
• Italy's FTSE MIB rose 2.09%
• Portugal's PSI20 rose 1.38%
• German Dax rose 0.6%
• France's CAC rose 0.5%
• UK FTSE rose 0.5%

Elsewhere, the dollar was on the backfoot, barring a reversal in the yen, on the back of data disappointments: The US Q1 GDP second reading q/q annualized +2.2% vs +2.3% expected, ADP US May employment +178K vs +190K expected. The Beige Book, on the other hand, said that the US 'expanded moderately' as manufacturing picked up).

Key headlines:

• Fed's Beige Book: Prices rose moderately in most Districts
• Italy’s 5-Star leader Di Maio: 5-Star and League never sought euro exit
• Italy: 5-Star calls for Savona to withdraw candidacy for econ min to allow govt formation
• US: Real GDP increases 2.2% (preliminary) in Q1 to miss market consensus of 2.3%
• Saudi Arabia, OPEC and non-OPEC producers to continue cooperation until end of 2018 - Reuters
• Dallas Fed: Texas service sector activity expands at an accelerated pace
• Fed's Beige Book: Prices rose moderately in most Districts
• Canada: Current account deficit rose by $3.0 billion in Q1 to $19.5 billion
• US: Private sector employment increased by 178,000 jobs in May - ADP
• Germany: Annual Harmonized CPI up 2.2% in May