MBS Live Day Ahead: How did Such a Good Week Happen?

If you'd just had your worst week in 7 years, it's always nice if the next could be markedly different.  That's the case for bond markets this week, assuming nothing outrageous happens for the rest of the day.  In fact, if markets closed right now, this week's gains would easily outpace last week's losses.

Who can we thank?

In a word: Italy.

More than anything, it's been the downward spiral in Italian politics fueling a rally in safer-haven bonds (like Treasuries and German Bunds).  

Who cares about Italy?

More people than you might think.  Even though it's only one of 19 countries in the Eurozone, it's important for a few reasons.  First off, it's the 3rd biggest economy in Europe, so the economic impacts of any Italian drama can't easily be brushed off.  Just as important is the fact that it's a Eurozone nation (meaning it shares the Euro currency).  

In thinking about why the Euro currency is a factor, remember Greece--a much smaller economy that nonetheless was seen as a harbinger of doom for the entire European Union.  At least in Greece's case, quarantine would have been much easier if it was not sharing the same currency with the rest of the Eurozone.  In Italy's case, however, its size means that the rest of the European economy will take a hit if there are any big, negative changes.  

But even more important than economic fallout or shared-currency concerns is the risk that the new political party in Italy pushes the country out of the Eurozone and/or the EU itself (a la Brexit).  To many, this would be the proverbial 2nd domino that all but guarantees additional EU departures by other countries with populist uprisings.  The economic and monetary impacts of such an unraveling can only be guessed at, but none of the guesses are positive.  And massively negative risks are where big, stable bond markets shine.  Thus the shiny week for Germany and the US.