Italy and Bernanke Testimony

We have had a wild ride in the market for the last few days due to the rise in yields for Italian govt bonds. This raised the fear that maybe the European crisis is spreading to Italy. Italy is a larger economy and has the 3rd largest govt. bond market in the world. It would be very hard to really bailout Italy. But fortunately Italy’s problems are not as bad as Greece. Although Italy has a high debt/GDP, the current deficit is not high and most of Italian government bonds are owned locally. Local investors have a higher likelihood of reinvesting than international investors. After the initial fears I think the market is starting to stabilize as market participants realize the Italian situation may not be as bad.  The scary thing about debt markets though is that once fear crosses a certain threshold it causes a reinforcing feedback loop and even a healthy situation becomes unsustainable.

Today we are having a mini-rally which is mainly being driven by Fed chariman Ben Bernanke’s testimony to Congress. In his testimony he alluded to possible further monetary stimulus measures if the economic situation deteriorates further and deflation becomes an issue. Bernanke did add that he doesn’t think this is the likely scenario. Due to this small hint of further stimulus, we are seeing a fall in the dollar, a rise in Gold and a rise in the stock market.

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