Italy's Five Star/Lega coalition government was certainly dreadful for investors, but by imposing a technocratic alternative, the president of the Italian republic might have played right into the populist parties' hands.
The sell-off witnessed following news that the Five Star/Lega coalition would not take power, with a technocrat government led by the pro-European Union Cottarelli established in its place until another round of elections, demonstrates that markets think things are poised to get worse even though the populist coalition didn't get its way.
The government proposed by the two parties last week was shaky and it was obvious that while its policies would have hurt the EU's third-largest economy, the coalition would have been short-lived due to the vast differences between the two parties. The blockade of this proposal, however, makes the Five Star/Lega coalition more dangerous.
It does not matter whether new elections will be held tomorrow, in three months or in a year: what is clear is that the longer it takes for new elections to take place, the more time the coalition will have to organise itself and return to the ballot booth stronger than ever.
At that point, they will be unstoppable.
The anti-austerity mandate that Italians have expressed at the beginning of March has not led anywhere, and euro-sceptic sentiment is strong within among Italian citizens. This could increase the risk of an 'Italexit' exponentially, which after Brexit would pose a death sentence to the EU as a whole.
In this highly volatile environment, however, opportunities will arise – but we have to be very careful to what risks we are willing to take on as we have learnt over the past few days that things can quickly turn sour.
Italian yield curve flattest since 2011 (two-year BTPS up 184bps to 2.70%): is this the dip?
Yesterday, the Italian yield curve flattened the most since the European debt crisis in 2011 as selling pressure was felt on the shortest part of the curve. The spread between the 10- and two-year BTPS reached 36.66 bps with the two-year at 2.70%, a huge spike considering that it closed at 0.868% just the day before.
Selling pressure was felt even though real money didn’t change its overall strategy towards the periphery which raises a valid point: how much can BTPs fall if real money investors start to move away from this space due to intensified periods of volatility and possible credit downgrades?
It is safe to assume that the spread of the 10-year BTPS versus the 10-year German bund can return to its 2011-2012 level near 500 bps as support from real money diminishes?