Merkel and other European Union leaders defied expectations to forge an accord early on Friday, putting the onus on Bavaria’s ruling CSU party that sought the clash. Its leaders must now decide at a meeting Sunday whether to risk a historic breakup of the party bloc that’s governed Germany for most of the time since World War II or beat a face-saving retreat.

With migration hard-liners Italy and Austria backing a coordinated European approach at the summit, the CSU appeared increasingly isolated before deciding whether to defy Merkel and start sending back asylum seekers at the German border who already registered in another EU country. Polls suggested public support for the Bavarians’ stance is waning.

“At this point, the CSU can’t afford to dig in against a compromise,” Juergen Falter, a political scientist at Johannes Gutenberg University in Mainz, said by phone. “They’d come across as troublemakers.”

As investors welcomed the summit result, the CSU said the deal addressed concerns about migration it has raised for a long time. Merkel’s Christian Democratic Union, the biggest party in her governing coalition, rallied behind the chancellor.

“Now these measures actually need to be implemented,” Alexander Dobrindt, the CSU caucus leader in the German parliament, said in a statement. The Bavarian party will review the summit deal “very thoroughly,” he said.

Eoin Treacy's view

There is no more useful political manoeuvre than the “bait and switch”. It seems any politician who wants to stick around needs to master it and Italy’s populists are obviously quick studies.  By focusing on immigration rather than tax cuts and spending, the new Italian administration threw focus onto Angela Merkel’s less than comfortable position on the topic of migrants and diverted attention from the looming wall of debt Italy needs to refinance.

Italy has raised the prospect of BOTs and of breaking the EU’s fiscal rules with the result its 2-year yield went from negative 30 basis points in early May to a peak of 284 at end of May. A 3% move over the course of a month is enough to give even the most fervent advocate of fiscal profligacy some pause. There is a simple fact underlying every decision Italy’s new administration has to make. The country has almost as much debt to refinance this year as the USA. Therefore, the most likely scenario is that Italy will continue to play the anti-immigration card while remaining quiet about the fiscal splurge that was part of the election campaign, at least over the summer when the majority of politicians go on holiday.

Italian 2-year yields have compressed since the late May spike and a sustained move above 1% will ned required to signal heightening anxiety toward the market.

Meanwhile German debt continues to trade at negative yields out to maturities of at least seven years. The ECB has bought a lot of that debt since Germany is the Eurozone’s largest economy and plans to stop net new purchases in September. That holds out the prospect that German yields will rise, just as they did with the end of quantitative easing in the USA and that would put pressure on the bond markets of peripheral nations that trade at spreads over Bunds. I believe that is one of the primary consideration behind the continued underperformance of Eurozone stock markets.