Italy Doesn’t Look Like It’s Fixed. Actually, It Kinda Looks Like Traders Are Fumbling Around In The Dark For An Equilibrium That May Not Exist.

Italian assets are under pressure again on Wednesday, adding to declines seen on Tuesday following Giuseppe Conte’s first speech as Italian PM.

The BTP curve resumed bear flattening, with 2Y yields up sharply, to their highest since last Thursday:

As you can see, yields were up 44bps at one juncture. Traders cited thin liquidity and poor volumes in the cash market. “There continues to be appetite from existing BTP holders to reduce risk exposure, particularly in the front-end,” one of the traders who spoke to Bloomberg said.

Obviously, the bear flattening is indicative of folks continuing to price in default risk and the comments from ECB officials about next week’s meeting being “live” only add to the angst (even if they push bunds lower and thus mechanically pressure the BTP-bund spread tighter). Remember, “live” in this context just means it’s possible they’ll give some kind of guidance as to when QE will be wound down – they’re now telegraphing the telegraphing. Or, as Lisa succinctly puts it:

It's kind of amazing that the ECB has to spend so much time deciding whether or not to even talk about exiting its bond-buying program. https://t.co/3WcxjoBmeD

— Lisa Abramowicz (@lisaabramowicz1) June 6, 2018

As alluded to above, there was some initial, mechanical tightening of the BTP-Bund spread (“lo spread” as the Italian populists derisively call it) on Wednesday as the “hawkish” ECB rhetoric pushed German yields higher, but if you look at an intraday chart, you can see that the tendency is for this to continue to widen:

And have a look at Italy CDS on the day:

We’re not back to last week’s wides yet, but dammit we’re getting there:

So I don’t know. This doesn’t necessarily mean that the jitters about Italy’s new government aren’t overblown – they very well might be.

But what it certainly does suggest is that folks are still searching for some kind of equilibrium (especially at the front end of the BTP curve) and until they find it, introducing more uncertainty is only going to mean more volatility, which I guess is what makes the June ECB meeting so precarious.