If investors thought the temporary shock waves created by Italy’s political turmoil earlier this week was bad, they should imagine what it would have felt like if global central banks weren’t still providing support via easy monetary policy.
Those are the concerns by some investors who say the strength of the flight-to-quality rally in Treasurys and the selloff in Italian government paper earlier this week underscored the potential for a more frenzied market when central bankers have made further headway in normalizing policies.
See: Watch the Fed as Italy’s crisis puts it in the hot seat[1]
“All the Italian political headlines so far have occurred against a backdrop of incredibly easy monetary conditions, and should such events transpire in the future, their impact on markets will be even greater as the cushion against such shocks will be much thinner,” said Aaron Kohli, fixed-income strategist at BMO Capital Markets.
The European Central Bank and the Bank of Japan are still adding to their crisis-era portfolio of securities. Meanwhile, the Federal Reserve, the central bank making the most progress among its peers toward normalizing monetary policy, remains a few hikes away from what’s widely viewed as the neutral interest rate, the threshold above which interest rates can start to crimp economic activity.
On Tuesday, the rout in Italian government paper saw the 2-year note yield TMBMKIT-10Y, -3.39%[2] climb more than 150 basis points, to post its largest one-day jump in more than 25 years. Bond yields move in the opposite direction of debt prices. Meanwhile, investors rushed into U.S. government bonds, pushing the 10-year Treasury note yield TMUBMUSD10Y, +0.60%[3] 15.9 basis points lower to post its biggest one-day drop since June 24, 2016, the day after Britain voted to leave the European Union.
Stocks came in for a similar bruising. The Dow Jones Industrial Average DJIA, -1.02%[4] ended nearly 400 points lower, a decline of 1.6%, while the S&P 500 SPX, -0.69%[5] shed 1.2%. The Stoxx Europe 600 Index SXXP, +0.70%[6] fell 1.4%, its largest single-day drop since March 22.
The storm soon abated and Italian bond yields subsequently trimmed their climb. The...