Picture: THINKSTOCK
Picture: THINKSTOCK

LONDON — World stock markets and southern European government bonds sank on Tuesday on fears that political gridlock in Italy would leave its economic reforms in tatters and reignite the eurozone’s broader debt crisis.

However, US stocks, which fell in reaction to the Italian election outcome on Monday, were poised to open higher, with investors awaiting testimony by Federal Reserve chairman Ben Bernanke on future policy direction.

But the uncertainty generated by the Italian poll was still rattling most other major risk asset markets, with Italy’s 10-year bond yields, which rise as prices fall, up as much as half a point to 4.86%, their highest since mid-December.

Investors also sold Spanish and Portuguese debt and sent Brent crude oil prices down to $113 barrel, their lowest level in a month, while safe-haven assets such as gold and German government bonds rallied.

"The main driver now is the deadlock after the Italian election — it’s triggered risk-off sentiment in the financial markets," said Carsten Fritsch, commodity research analyst at Commerzbank in Frankfurt.

Investors are fearful the strength of the vote for anti-austerity parties at the election will weaken efforts to reform Italy’s public finances and its labour laws, damaging the eurozone’s efforts to resolve its three-year-old debt crisis.

"What’s important is to understand if, in fact, this (vote) against austerity is also against reform, which clearly is still very important to Europe, and to Germany as well, with the elections coming in September," said Virginie Maisonneuve, head of Global Equities at Schroder Investment Management.

Last year’s promise by the European Central Bank (ECB) to provide unlimited support to struggling eurozone nations provided some reassurance to investors, allowing many to wait for greater clarification on Italy’s next step.

"A lot of our clients are in a ‘wait and see’ mode looking to sit on their current holdings to see how the situation develops," said Lyn Graham-Taylor, fixed-income strategist at Rabobank.

"Obviously they will become active once the political situation becomes clearer," he said.

Italy’s and Spain’s need to change the shape of their economies, get growth going and debt down have been at the heart of the eurozone’s troubles for more than a year, but the fears have eased substantially since the ECB made its support clear.

The uncertainty weighed on European share markets, dragging the pan-European FTSEurofirst 300 index down nearly 1%. London’s FTSE 100 was down 1.25%, while Paris’s CAC-40 and Frankfurt’s DAX were down as much as 1.7%.

MSCI’s broadest index of Asia-Pacific shares outside Japan fell 0.9%, sending the MSCI world equity index down 0.6% to 349.1 points.

The inconclusive outcome in Italy cast a further shadow over the euro, which had hit a high of $1.37 at the start of the month before steadily losing ground as economic data showed the region’s economy was still struggling.

The euro traded around $1.3050 on Tuesday, just above seven-week lows, while against the yen it was up 0.4% at ¥120,39.

"We have seen a cautious bounce (in the euro), but it doesn’t look like we are seeing anything durable here," said Jeremy Stretch, head of currency strategy at CIBC.

US worries

Investors were also nervous before testimony later in the day from US Federal Reserve chairman Ben Bernanke, who could give further clues to when the central bank intends to slow down or stop its bond-buying programme.

Financial markets were rattled last week when minutes of the Federal Reserve’s January meeting showed some officials were thinking of scaling back its monetary stimulus earlier than expected.

Also of concern to many is the darkening outlook for global growth, with sharp budget cuts due to take effect in the US on Friday, and weak data from China revealing a growing slowdown in its export-oriented manufacturing sector.

The uncertainty has led to a sharp rise in volatility, with the Chicago Board Options Exchange’s widely watched Vix Index jumping 34% on Monday for its biggest one-day gain since August 2011.

Europe’s equivalent index, the VSTOXX, which reflects options pricing and demand to protect against falls in the underlying cash market, rose 15% on Tuesday to hit a new year’s high of 24.73.

Reuters