Good News: Brussels Has Decided Not To Sanction The Italians

Good news (and I only mean that half sarcastically)! The EU has decided that in light of the country’s new conciliatory budget stance, the Italians don’t need to be sanctioned.

The concessions from Rome have been in the news since last week and it’s been clear since September (when Salvini and Di Maio effectively overruled Tria on the way to proposing a 2.4% target that everyone knew would never fly in Brussels) that Italy would have to cave or risk another BTP meltdown like that witnessed in late May when liquidity disappeared, bid/asks blew out and 2-year yields exploded to the upside in what amounted to a black swan moment for the Italian short end.

In the months that followed the late May drama, things calmed down a bit, but tensions flared anew in September and the budget battle between Rome and Brussels has been raging since, heightening political risk in Europe at a delicate juncture. Given that the ECB was (basically) the only net buyer of BTPs for an extended period of time, the end of asset purchases posed a serious risk to the Italian bond market if political turmoil had extended into the new year.

Make no mistake, Italy isn’t out of the woods yet (far from it), but today’s news that Italy will apparently avoid the excessive deficit procedure is enough to spark a rally in BTPs and Italian financials. On the former, here’s March futures:

(Bloomberg)

On bank stocks, the FTSE Italia All Share index is obviously surging, up more than 3% on the day.

(Bloomberg)

But we’ve seen this movie before and these rallies seem to always give way to some new batch of negative headlines. You’re reminded that Italian banks are still down an egregious ~48% from the highs (green highlight over there on the right-hand side in the bottom pane is today’s rally).

(Bloomberg)

As for the nefarious (and the “nefarious” characterization only applies if you’re like Salvini and you think the spread between two bond yields is a living, breathing thing, capable of having a sense of purpose) “lo spread”, we’re back below 255bps thanks to today’s BTP rally.

(Bloomberg)

Below is the bigger picture on that which captures the late May chaos and I guess what I would immediately note just from looking at it for two seconds is that once it gets back near those levels that prevailed right before Salvini and Di Maio’s decision to thumb their noses at Tria’s budget suggestion in September, you should probably expect the compression to stall absent any further good news – in other words, it looks like this has another ~25bps or so to run before we’ll need some other definitively positive catalyst.

(Bloomberg)

So, again, all is well – at least for today.

But as noted above, this is far from over and you can be absolutely sure you’ll hear more in the weeks and months ahead from Salvini and Di Maio about the extent to which their election promises are being stymied by the eurocrats. Don’t be surprised if Salvini attempts to somehow consolidate power – League’s support is stronger than Five Star’s and he seems to have had enough of the internal coalition bickering.

Anyway, the bottom line on Wednesday is this from Dombrovskis:

Intensive negotiations over the last few weeks have resulted in a solution for 2019. This allows us to avoid an Excessive Deficit Procedure at this stage stage if agreed measures are fully implemented.