FRANKFURT (MarketWatch) � Italians went to the polls Sunday in the first step of a two-day election to pick a new prime minister as investors wondered whether a strong showing by Silvio Berlusconi could dent a rally that�s lifted European and U.S. stocks to multiyear highs in 2013.
The vote has been pegged as a referendum on the austerity and reform agenda of Prime Minister Mario Monti, the nonpartisan technocrat selected to take the reins of government after Berlusconi was forced out of office in disgrace in November 2011.Click to Play Grillo is wild card in Italy elections
Italian newspaper La Stampa's Marcello Sorgi looks at the success of former comedian Beppe Grillo. And how he will have enough votes in the Italian election to be a formidable opposition and may prevent Italy's future government from being effective. Photo: Getty Images
Market participants appear to have already priced in the �best-case� scenario � a center-left victory by Pier Luigi Bersani�s Democratic Party in the lower house and a Senate result that forces Bersani to team up with Monti for an upper-house majority, according to Heino Ruland, a strategist at Ruland Research in Eppstein, Germany.
That leaves European equities and financial markets in general vulnerable to disappointment, he said, but would probably leave U.S. equities unscathed.
Voting continues through Monday, with early results expected shortly after polls close. Strategists see plenty of scope for the outcome to unsettle markets in general, at least in the short term.
�We believe Italy is headed for postelection instability, with disagreements over the pace and direction of economic reform,� said Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London consulting firm.
�Paradoxically, the messier the election result, the greater the pressure on Italy�s politicians to form a stable and market-friendly government �especially if Mr. Berlusconi pulls off an upset victory,� he said.Click to Play Europe's week ahead: Bernanke, Italy and Japan
Dow Jones's Andrea Tryphonides and MarketWatch's Sara Sjolin run through the wide mix of events that are likely to buffet markets, including Bernanke's testimony that might clarify Fed policy, Italy's very uncertain elections and the appointment of a new Bank of Japan governor.
Major U.S. and European stock indexes have rallied since European Central Bank President Mario Draghi late last July put Europe�s debt crisis on the back burner. Market participants appeared unconcerned on Friday, with the S&P 500 SPX posting solid gains and the Stoxx 600 Europe index XX:SXXP jumping 1.3%. See: U.S. stocks extend gains.
Draghi first pledged to do �whatever it takes� to preserve the euro in late July, then followed it up with a bold plan that would see the ECB conditionally but aggressively buy government bonds if needed. That�s served to squelch fears that soaring borrowing costs would drive the likes of Italy, Europe�s third-largest economy, or Spain, its fourth-largest, to seek massive bailouts, even though neither country has yet applied for help.
The Wall Street rally has been attributed to a host of factors that have little to do with Europe�s long-running debt crisis. But the lack of scary headlines out of the euro zone has removed one source of periodic fear from the market. An unsettling outcome in Italy, however, could set up a test of market faith in the ECB�s bond-buying program, analysts said.Reuters Enlarge Image Italian Prime Minister Mario Monti
Monti, meanwhile, has won qualified praise for his efforts to overhaul labor, pension and other work rules in an attempt to boost Italy�s competitiveness, while also attempting to get Italy�s growing debt pile � at 126% of gross domestic product � under control.
But Monti faces public resentment at home over a steep recession that has pushed the unemployment rate above 11% and is blamed in part on the government�s austerity drive.
Berlusconi has campaigned against an unpopular real-estate tax, and has mocked Monti�s focus on narrowing the yield premium � or spread � demanded by investors to hold Italian government bonds over safe-haven German bunds. See: Berlusconi shouldn't be counted out in Italy.
/quotes/zigman/4869096/delayed 10YR_ITA 4.48, 0.00, 0.00% From crisis to calm Italian bond yields have fallen back from crisis levels.
Italian yields have backed up since January, with the 10-year IT:10YR_ITA at 4.40% on Friday, according to FactSet.
Still, that�s far off the nearly 6.5% yield on Italian bonds, known as BTPs, seen before Draghi�s �whatever-it-takes� pledge in July and the panic-inducing 7%-plus yields seen in November 2011.
Gyrations in peripheral euro-zone bond markets often set the tone for global financial markets, with spiking yields leading investors to shun equities and the euro in order to seek haven assets, including the U.S. dollar, Treasurys and German bunds.