Dow plunges nearly 400 points and European stocks suffer as Italian candidates threaten to leave the euro

Fear of instability in the euro zone rekindled fears of more financial strain for weaker European nations

PUBLISHED : Wednesday, 30 May, 2018, 5:08am
UPDATED : Tuesday, 03 July, 2018, 7:59pm

Stocks in the US and Europe sank on Tuesday after political turmoil in Italy – which could result in another election and the rise of anti-Euro parties – stoked fears of instability in the euro bloc.

Investors dumped Italian government bonds, driving borrowing costs sharply higher for that country and rekindling fears of more financial strain for weaker European nations.

Political crisis in Italy revives fear of a euro-zone meltdown

Meanwhile, prices for US government bonds surged as investors shifted money into lower-risk investments.

The steep drop in US bond yields is causing big losses for banks. Lower yields force interest rates down on mortgages and other kinds of loans, meaning thinner profits for financial institutions. Major exporters like technology and industrial companies also fell.

The political upheaval in Italy is likely to lead to new elections in the coming months, and while it’s not clear if Italy would leave the euro, investors are interpreting the new vote as a referendum on Italy continuing to use the currency. That has major implications for the European financial system and its economy.

“Euro zone membership will be at the forefront of the next election,” said Alicia Levine, the head of global investment strategy at BNY Mellon Investment Management. “Should Italy leave the euro zone, it’s clearly bad for European assets and it’s bad for the European banking system.”

If EC President Juncker has doubts about outcome of Italy’s election, markets should too

Investors sold stocks, especially companies that depend on strong sales outside the US like technology and industrial companies and big drug and health care products makers. They bought government bonds in the US as well as Germany and the UK. That sent prices for those bonds higher and yields lower.

The S&P 500 index sank 31.47 points, or 1.16 per cent, to 2,690. The Dow Jones Industrial Average lost 392 points, or 1.2 per cent, to 24,361. It was down as much as 505 earlier. In Europe, Italy’s benchmark stock index plunged 2.7 per cent.

The Nasdaq composite fell 37 points, or 0.5 per cent, to 7,397.

Italian President Sergio Mattarella picked Carlo Cottarelli for prime minister after the anti-establishment 5-Star Movement and right-wing League refused to withdraw an anti-euro candidate as economy minister.

That ended their attempt to establish a government after inconclusive elections in March. Cottarelli is likely to lose a vote of no confidence in Parliament, which would mean another round of elections.

Investors dumped Italian stocks and bonds as a result. Yields on Italian government bonds soared as their prices declined. The yield on the 10-year Italian government bond jumped to 3.10 per cent from 2.69 per cent, a huge move.

At the beginning of May the yield was just 1.78 per cent. The sharp move higher reflects weakening confidence among investors in Italy’s government.

The German DAX lost 1.5 per cent, and Britain’s FTSE 100 and the French CAC 40 both sank 1.3 per cent. Some of the worst losses went to European banks: Germany’s Deutsche Bank dropped 6.5 per cent to $11.27 and Banco Santander of Spain lost 9.7 per cent to $5.28.

“Uncertainty and the unknowns themselves affect the real economy,” said Levine, of Bank of New York Mellon. “You’ve going to have less investment, you’re going to have a decline in consumer spending, you’ve going to have, on the margin, less consumer activity affecting growth.”