Whats the latest in Italys political drama?

Markets are finding their footing Wednesday, as traders work out what might come next in Italys latest political drama.

Italys equities and bonds, the euro and U.S. stock futures are all in recovery mode.

Whats happening, and whats next?

Italy reportedly could hold an election again as soon as July, now that would-be Prime Minister Carlo Cottarelli is struggling to find support for a caretaker government. Early Tuesday, the next election seemed pencilled in for September.

A coalition government led by antiestablishment parties also might be in the cards again, after looking blocked earlier in the week. Local media have said a populist group involving the 5 Star Movement and the League party was pushing to form a coalition.

Cottarelli met with Italian President Sergio Mattarella early Wednesday, but then made no announcements. Italian newspaper La Repubblica speculates that either the duo is either giving the euroskeptic parties another crack at establishing a government or picking ministers for a caretaker government is proving more complicated than expected.

Matteo Salvini, the League partys leader, said Wednesday that the country should vote again as soon as possible, according to a Reuters report. But he also left the door open to other solutions in his remarks.

Reports say 5 Star and League may pull in another right-wing party, the Brothers of Italy, to their bid to form a government.

Why does it matter?

Headlines out of Rome over the weekend sent shock waves through global markets and contributed to a selloff for stocks worldwide on Tuesday, as well as denting the euro and sending Italian bond yields skywards.

Fears over the prospect of a euroskeptic coalition government in the eurozones third-largest economy drove the moves, as investors fretted about the return of a euro crisis and the impact of an implosion in Italys massive debt.

Check out: How Italy revived euro-crisis fears and sparked a global stock market selloff

In March, an election in Italy failed to produce a conclusive result, leading to weeks of jockeying. Over the weekend, the anti-establishment the 5 Star Movement and far-right League, a pair of euroskeptic parties who had agreed to work together, were on the verge of forming a coalition government. But Mattarella squelched the choice of a euroskeptic economy minister, appointing a new prime minister who isnt expected to garner the parliamentary support needed to form a lasting government.

Investors fear that election could see the anti-establishment parties, which had backed away from outright euroskeptic rhetoric in the run-up to the March vote, adopt more strident positions, potentially turning the vote into a de facto referendum on the countrys euro membership.

What are markets doing?

Italys FTSE MIB stock benchmark
I945, +1.33%
was recently up 1.4% to 21,660.34 following Tuesdays tumble of 2.7%. Italys 2-year bond yield
TMBMKIT-02Y, -21.34%
was down to 1.942% as prices rose, after topping 2.4% on Tuesday.

The pan-European Stoxx Europe 600 Index
SXXP, +0.05%
edged up 0.1%, while futures for the Dow Jones Industrial Average
YMM8, +0.54%
and S&P 500
ESM8, +0.49%
were about 0.3% higher.

The euro
EURUSD, +0.6759%
rose to $1.1583 from $1.1541 late Tuesday in New York.

President Mattarella is drawing flak

The president has made a major tactical blunder, wrote former Greek finance minister Yanis Varoufakis in a Guardian column that blasts Mattarella.

The formation of another technical government, under a former IMF apparatchik, is a fantastic gift to Salvinis party, he said.

Read: Rise of Italys xenophobes was guaranteed by Merkels refusal to reform eurozone, says Varoufakis

Other analysts are drawing similar conclusions about Mattarellas move.

By openly invoking the role of investors, financial markets and the defense of the eurozone in his speech on Sunday, the president lends credence to the populist argument that Italy has become the battleground in a war between the international establishment and national democracies, said a Wall Street Journal column by Francesco Ronchi, a lecturer at the Paris Institute of Political Studies, or Sciences Po.

It could end up as a case study in how liberal democracies commit suicide, Ronchi said.

William Watts contributed to this report.

Victor Reklaitis

Victor Reklaitis is a London-based markets writer for MarketWatch. Follow him on Twitter @VicRek.

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