The bond market continues to rally today as risk appetite retreats further thanks to escalating concerns regarding Italy’s solvency. Yields on Italian bonds have jumped (e.g. five years at 7.5%) and the yield curve is now inverted, despite the announcement that PM Silvio Berlusconi intends to resign after the passage of the austerity package that is currently working its way through parliament. The increase in yields has been exacerbated due to higher margining requirements imposed by clearinghouses, reflecting higher perceived default risk.

Whereas the Greek economy and debt burden are small enough to be controlled by the EU-member states, Italy is simply too big to receive a bona fide bailout so the new Italian leadership will have to do most of the heavy lifting.

Speaking of Greece, talks there regarding the formation of a transition government are now in their third day, adding to unease in markets.

The bond market has been considerably less volatile this morning and yesterday than it has been in the recent past thanks to a moderation of the drama in Europe. Greece is currently in the process of cobbling together a transitional government whose sole purpose will be to pass the October 26 bailout agreement and then hold elections in February (with the PM to step down immediately), and while it is not yet complete it appears likely that Greece will accept the terms of the agreement.

As the problem with Greece appears to be subsiding for now, markets have fixated their glare on the situation in Italy. Whether or not these concerns are justified is yet to be seen, but the market focus has catalyzed action in the Italian parliament. Parliament will soon vote on a new austerity budget, and PM Silvio Berlusconi is facing increasing calls to step down as a condition for the support of the said budget by his coalition partners. On the whole, markets seem to be reacting favourably to developments in Italy and that process will continue to receive considerable attention until resolved.

Other than that, there was some positive news in Canada with 207,600 Housing Starts in October surpassing market expectations for 195,000.

The bond market has rallied this morning and much of it has to do with economic performance in the US and Canada, with both nations posting disappointing October employment reports.

The Canadian report was the weaker of the two by far. Reported net change in employment of -54k jobs masks the underlying elimination of 71.7k full-time jobs in favour of +17.7k part-time jobs created. Expectations were for a +15k print. These losses drove the unemployment rate from 7.1% to 7.3%.

The US report was more moderate. The market expected +125k jobs but only got +104k, with the unemployment rate there declining from 9.1% to 9.0%. Positively, the revision of the September jobs report raised the print for that month up from 137k to 191k.

Of course, the Greek situation continues to develop with global ramifications. The Greek PM withdrew the plan to hold a referendum on the the bailout agreed last week on the basis that the most members of parliament had agreed on the need to ratify the agreement, thereby representing a strong majority. Prior to the referendum announcement, the opposition, led by the PM’s former college roomate Antonis Samaras (surprise) had been critical of the plan so the referendum call seems to have created a strong consensus where it previously lacked.

Unfortunately for the PM, this consensus seems to have extended to united calls for his resignation and it is being reported that he has agreed to step down after tonight’s vote of confidence (scheduled for around midnight local / 6pm EDT) in favour of a coalition government that would approve the bailout and then call an election. When a situation evolves as rapidly as this one has, it is difficult to say how long information remains current or even how accurate it is so expect markets to react as additional news comes out of Greece today.

The Greek government shocked markets late yesterday afternoon by announcing that they will take last week’s tentative deal to a national referendum prior to ratification. While the hat tip to Democracy is admirable, the fact that the same folks who have been protesting rather passionately now get to vote on the acceptance of the package has markets justifiably nervous. The bond market rallied sharply yesterday afternoon as has continued to do so this morning, while European equity markets are down some 4-5% today.

While the intention is to hold the Greek referendum sometime in January, the government had announced that it will put a no-confidence vote on the table for later this week. Additionally, I have just read on Bloomberg that the Greek PM has been asked to step down by six senior members of his own party.

Needless to say the political situation in Greece is evolving rapidly and unpredictably, and it is very clear that all of these developments – from the announcement of the referendum onwards – have caught European leadership by surprise.

There is some US data out at 10am (Construction Spending, ISM Manufacturing Index) but the European situation is certain to direct markets as details and reactions continue to emerge.

Later this week data includes:

US: ADP Employment, Fed Meeting (Wed); Productivity, Factory Orders, ISM Non-Manuf Comp., Initial & Continuing Jobless Claims (Thu); Employment Report (Fri)

Canada: Employment Report, Unemployment Rate, Building Permits (Fri)

The bond market is adding to the recent rally as concerns about a Greek default have intensified (again). An announcement yesterday – that a larger than hoped-for contraction in their economy meant that Greece would fall short of deficit targets agreed upon as part of its bailout package – created concerns in markets about the bailout being shuttered, renegotiated, etc. and such level of uncertainty is wholly counterproductive. It is not surprising to see global equity markets suffering large losses over the past several days as funds flow into the relative safety of government bonds.

Some important data will also be released this week as well.

US: ADP Employment Report, ISM Non-Manufacturing Composite (Wed); Initial and Continuing Jobless Claims (Thu); Employment Report, Wholesale Trade, Consumer Credit (Fri)

Canada: Building Permits (Thu); Employment and Unemployment Rate (Fri)

The bond market has followed Friday’s sharp rally with further rallies on Monday and through this morning, although the rally has faded since early am today.

The primary culprit is ‘Europe’ – not only did politicians actually start talking about a formal Greek default openly this past weekend, but Italian bond yields have been rising as the debt contagion enters a very dangerous stage. Italy’s economy is as large as Greece, Portugal, Ireland, and Spain put together so the mere thought of a crisis there has caused markets to take a more defensive approach. Italy’s parliament has proactively engaged in budget talks aimed at eliminating that country’s deficit by 2014.

In addition to the European sovereign issues, the US  continues to deliberate on a budgetary package that will get the number of votes necessary in Congress to raise the debt ceiling before the government runs out of the ability to borrow further during the first week of August. Republicans, who raised the debt ceiling some seven times under George Bush, are opposed to any tax increases, while Democrats are opposed to cutting spending on social programs such as medicare and social security.

Expect these global issues to dominate markets over the coming weeks. In terms of hard data we can watch for, the US is releasing Retail Sales and Business Inventories on Thursday, and the Consumer Price Index, Empire State Manufacturing Index, Capacity Utilization, Industrial Production, and Consumer Sentiment (all Friday). Canada releases Manufacturing Shipments on Friday.

Following the steep selloff in the bond market last week, it was not surprising to see a bit of a bounce early this week but the rally has picked up steam due to some key global factors. Front and center was the third rate hike of the year in China – tighter lending conditions in a key cog in the global recovery does not bode well for risk assets – which is helping drive funds back into bonds.

Also, Moody’s four-notch downgrade of Portugal to Ba2, a non-investment grade rating level, reminded everyone that the Eurozone fiscal troubles run well beyond Greece and were not permanently solved last week.

The rest of the week will be pretty eventful with respect to data. For Canada, the Employment Report for June will be released Friday. For the US, we have: ADP Employment (Thu); Employment Report, Wholesale Trade, Consumer Credit (all Friday).

Rates shot higher last week by around 40bp as the EU, IMF, and ECB were able to come to an agreement to prevent a default of Greek sovereign debt, and those measures were passed by the Greek parliament. As markets had become concerned in recent weeks about a potential default and the knock-on effects of such an event (remember Lehman), money had poured into bond markets, driving rates lower. As those fears were addressed by last week’s aid package, some of those flows naturally reversed, driving rates sharply higher.

For a bit of local flavor, on Wednesday, Canadian Inflation numbers for May were reported and surprised the market as they were slightly higher than expected. While year-over-year core inflation of 1.8% remains below the Bank of Canada 2.0% target, the market had been expecting a 1.5% reading. Higher inflation readings lead to higher interest rates in the bond market.

Rates are up again this morning in what is the third day of a huge selloff in the bond market. This week, Greece agreed to the austerity measures the IMF, EU, and ECB had conditioned the release of the next support payment on, and today the Greek parliament agreed to the process by which these measures will be implemented.

As markets breathe a sigh of relief that the fiscal / debt crisis in the Eurozone is over for now, risk assets have regained some of their appeal.

Markets are of course closed tomorrow for the Canada Day holiday, and Monday should be light as well as the US celebrates July 4^th.

Rates have moved much higher over the past 24 hours. The bond market sold off steadily on Tuesday as the continuing efforts in Europe to stave off a Greek default appear to be bearing fruit. Positive progress in debating a package combining spending cuts and tax increases yesterday will be voted on later today. As the Greek dilemma had been a primary cause of rates declining so much over the past month or so, it is not surprising that a positive near-term resolution should unwind some of that activity.

Adding fuel to the selloff this morning was a surprisingly strong May inflation report for Canada. The market had expected YoY inflation of 3.3% but got 3.7%. The Core inflation reading, which excludes volatile food and energy components (and is the one the Bank of Canada bases rate decisions on), was up 1.8% Year over Year (exp. +1.5%), and 0.5% Month over Month (exp. +0.2%). This 1.8% YoY reading for Core Inflation is below the 2.0% the Bank of Canada is targeting, so there is still a bit of room but obviously less so than the market thought yesterday.

Some important data out Thursday includes Canadian GDP growth for April, and the Chicago PMI.