I’m not sure why anyone was inclined to believe Italian assets were going to take the weekend’s political news in stride.
Although it’s possible to conceive of new elections as a more market friendly outcome than the guarantee of a populist coalition government, the interim turmoil is most assuredly not what Europe needs at a time when the bloc’s economy is decelerating and as the ECB ponders winding down APP.
On Sunday, Five Star and League’s joint effort to form a government fell apart and on Monday, the market attempted to digest the deluge of Italy headlines with the U.K. and the U.S. on holiday, which means thin liquidity and everyone obsessing over something most people know absolutely nothing about (Italian politics).
Salvini was on Facebook issuing demands to Brussels and threatening to pull Italy out of the EU. He also accused Mattarella of siding with the EU over Italians and claimed he’s going to try and form a populist government anyway “with the people Mattarella rejected” (which apparently meant “with Savona”).
That triggered selling in everything and easily the scariest chart is this one which shows Italian 2-year yields surged as much as 50bps at the lows to close in on 1%:
Note that 2Y yields were negative in Italy before things started to fall apart recently. That is one hell of a swing (from sub-zero to 1%) and it underscores how distorted the market was by PSPP.
Amid the chaos, Mattarella asked economist Carlo Cottarelli to form a government. “The President has asked me to go before parliament with a program that will bring the country to new elections,” he said, after meeting with the President. If he can’t get a confidence vote, elections will be held “after August”.
There’s obviously no telling what would happen in new elections and that uncertainty is what’s killing markets. Italian equities, already on the brink of a correction, aggressively pared a fleeting early gain to trade sharply lower:
Notably, the banks are getting crushed again. The FTSE Italia All–Share Banks Index is now on the verge of falling into a damn bear market:
And the BTP-bund spread has now ballooned to 227bps (or thereabouts):
Also note that the banking sector is vulnerable to contagion from weakness in italian govies. See the right pane below:
Don't look now but there's an Italian sovereign-bank loop rearing its ugly head. pic.twitter.com/V0x9vFn1qr
— Tracy Alloway (@tracyalloway) May 28, 2018
Basically, this is a shitshow and you’ve got to think the ECB will need to take it into consideration when it comes to the forward guidance around ending APP.
It would probably not be wise to officially end asset purchases in September just as jitters about new Italian elections are peaking.
Italy from afar is definitely a Banana Republic. Italy close and personal is a country with painful and difficult to resolve issues on immigration, unemployment, poverty, infrastructure, inequality and corruption. If the EU does not acknowledge that all EU members states are not created equal and that solutions must be specific to the country in question there is a risk that the EU will fail. If Italy returns to an election (which is entirely possible at this point) the 2 anti-establishment parties will garner yet more votes and form an even stronger government. One can only hope that wisdom will prevail and Lega + 5 Stars will do the right thing and deliver a more restrained agenda. In any case today’s optics are terrible and the 2 parties existing and highly divergent agendas promising everything and nothing and their opposite spell trouble for the average Italian who not unlike the average American has bought into a false dream of redemption. If we think we have seen the worst we are the only fools. Too many Italians feel they have nothing hence nothing to lose. Sounds familiar?