Listen, let’s not get out ahead of ourselves by suggesting that shit’s falling completely apart in Europe thanks to a couple of ascendant populist parties with designs on pulling Italy out of the EU and ditching the euro in favor of a barter system based on espresso beans and short-term, non-interest-bearing Treasury bills printed by the country’s lottery ticket presses, ok?
I mean, no, Di Maio and Salvini aren’t going away and, yes, their “plan” would likely put Italy on an even more precarious fiscal path than it was already on, but what’s the worst that could happen?
Oh, that’s right. The worst that could happen is what happened over the weekend when, instead of just accepting the electoral mandate that Italians, in their infinite wisdom, gave the two idiots mentioned above, Mattarella decided to exercise a little benign paternalism by insisting that it was not a good idea to let octogenarian euroskeptic Paolo Savona be finance minister. That opened the door to new elections and also to the possibility that a newly pissed off Salvini will ratchet up the anti-EU rhetoric even further, which is exactly what he’s done over the past 48 hours.
Now, the timing of the new elections seems like it might coincide with the ECB calling an end to QE, setting the stage for the rug to be pulled out from beneath the Italian bond market and the price action you saw on Tuesday seems to reflect folks attempting to price that outcome in.
This situation is made worse by the fact that Italy’s banks are highly exposed to their beleaguered sovereign, which raises the specter of the old sovereign-bank doom loop (remember that, from the eurozone debt crisis?) reinserting itself into the market narrative.
A couple of weeks ago, in “Italy’s Populists Furious That Bond Spreads Are Trying To ‘Blackmail’ Them, But The Real Victim Here Is Price Discovery,” I took you through a needlessly esoteric discussion of the extent to which the ECB has suppressed price discovery in Europe. That post was full of superfluous pontificating on the post-crisis market environment, but the overarching point was that there is absolutely no telling what’s going to happen if the ECB pulls back from supporting Italian sovereign debt and also credit.
In that piece, I quoted League’s Matteo Salvini, who has variously suggested that the the BTP-bund spread is conspiring against Italy’s populists.
Of course the spread between yields on government bonds cannot “conspire” against anyone because spreads are just numbers and numbers, by virtue of being numbers, cannot have a sense of purpose. They cannot “conspire” anymore than coffee tables can conspire.
As for the argument that the spread is being manipulated by nefarious “eurocrats”, that’s actually correct – only in exactly the opposite way that Salvini is suggesting.
Spreads to bunds (and Italian yields more generally) are artificially suppressed in order to keep the market from punishing fiscal profligacy in Italy. That’s why, until about four weeks ago, “investors” (scare quotes there for a reason) were still willing to pay the Italian government for the “privilege” of lending it money for two years (negative 2-year yields on Italian debt) despite the fact that there literally was no government.
So yes, Matteo, it’s rigged all right. And it’s rigged in favor of Italy.
Implicit in that arrangement (i.e., implicit in ECB support) is the notion that the Italian government won’t do anything to put the country on the path to fiscal ruin. You can call that “blackmail” if you want, or you can even claim that some European countries have become debt serfs, but what you can’t very well do is decide you want to leave the euro, flip the bird to the ECB and then complain about it when the market decides you can’t borrow money at negative rates anymore.
Well as you’re no doubt aware, Italian bonds have been an absolute bloodbath this week and one of the debates folks were having on Sunday evening (when it became apparent that new elections were the most likely outcome after Mattarella declined to support Savona as FinMin) revolved around whether there would actually be a relief rally this week predicated on the notion that new elections later were preferable to a populist government now.
That made sense for a couple of hours until people realized two things. First, it’s possible that the freshly enraged populists get even more aggressive with the anti-euro rhetoric ahead of the new vote and second, the time table looks like it will line up almost exactly with the ECB’s expected September announcement of an end to QE. That latter point is a fucking disaster because it sets the stage for Draghi to announce the end of APP just as Italy is trying to figure out if they want to effectively reelect the populists with an even stronger mandate.
Hilariously (and predictably), Di Maio and Salvini are now claiming that the selloff in BTPs and the rally in German bunds proves the market isn’t really concerned about populism in Italy. To wit, from Bloomberg’s live blog coverage of the Italian meltdown:
The two Italian political party chiefs — Luigi Di Maio of the Five Star Movement and Matteo Salvini of the League — said Tuesday that the recent surge of “lo spread,” as Italians refer to the Italy-Germany yield differential, shows they’re not really the problem. The problem, Di Maio says, is the political uncertainty, which they could have soothed by forming a government.
To be clear, they’re right that things might have been less bad (and “less bad” is obviously something different than “good”) this week had the specter of new elections not been raised. But that’s not because investors would have been comforted by some kind of assumption about a Five Star-League coalition “soothing” uncertainty. Rather, if they had gotten the green light from Mattarella, it would have just meant that maybe they would shut the hell up for a couple of weeks while they get the ball rolling on governing. Instead, they’re going to keep shrieking on social media and talking about “lo spread” conspiracies until the next election.
As Bloomberg correctly notes, “in fact, investors are concerned the populists will come out stronger from repeat elections.”
In other words, either way Di Maio and Salvini are the problem. And to the extent they believe a flawed currency union is the root cause of Italy’s issues, they are certainly entitled to that opinion and God knows they are not alone in contending that the periphery has been marginalized.
But sooner or later they are going to have to be some semblance of honest with the public and admit that while the structure of the union might be effectively rigged in favor of the core, financial markets have been unequivocally rigged in favor of preserving market access for periphery borrowers, both sovereign and corporate, for years.
If they want to rebel and implement a “plan” that is out of step with the implicit conditions of ECB support, well then that’s their right as elected representatives of the Italian people, but they need to i) acknowledge that the act of doing that is likely to come with severe financial consequences that cannot be summarily dismissed as “a conspiracy”, and ii) commit to taking responsibility for at least some of those consequences, if only to calibrate expectations and foster trust among their supporters.