Markets take a breather from contagion

Global credit markets took a breather on Wednesday from the contagion unleashed by Italy's political turmoil.

Dovish comments from Federal Reserve chairman Ben Bernanke late on Tuesday helped calm the market mood, though the situation in Italy remains detrimental to risk appetite. Beppe Grillo, whose Five Star Movement party effectively holds the balance of power after this week's election, has reiterated that he won't support either of the two main parties in their efforts to form a government.

Italy therefore faces a political vacuum and another election is a likely scenario. Grillo is riding a wave of popularity and his anti-austerity, anti-euro stance is not conducive to market stability.

Italy's CDS were trading at 295bps today, some 50bps wider than Monday's close. It is worth noting that liquidity in Italian sovereign CDS has increased during the recent political upheaval. The number of daily quotes received in Markit's CDS pricing service jumped to levels reminiscent of last summer's sovereign crisis.

Sovereign CDS is not as liquid as it once was, partly due to the EU ban on naked protection buying, but there is still considerable activity and Italy is consistently in the top three most heavily traded names, according to DTCC data.

Italy managed to sell €6.5billion of bonds in an auction today, which was welcome news given the febrile climate. But yields were significantly higher than previous auctions last month, and the debt sale was no doubt supported by domestic banks, which ultimately depend on the sovereign and ECB for solvency and liquidity.

In the broader market, the Markit iTraxx Europe was 3.5bps tighter at 118.25bps, with banks recovering some of the ground lost yesterday.

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