“Stuff” just got serious in Europe as not only are Italian sovereign yields blowing out at a historically unprecedented pace but the systemic threat to the political union has exploded as George Soros warned “Europe is in existential danger; it is the harsh reality..”
And nowhere is that “harsh reality” more evident than in the credit markets ‘ISDA Basis’ which implicitly measures the possibility of Italian “redenomination” risk… simply put – the higher that red line goes, the less an ‘Italian Euro’ is expected to be worth relative to a ‘German Euro’…
As a reminder, FT explains that in 2014, a new global standard CDS contract was introduced, enabling holders to cash in not only if countries failed to repay their debts, but if they paid them back in another currency. Investors had lobbied for this change during the eurozone sovereign debt crisis, as the previous set of contracts, drafted in 2003, did not pay out if a country redenominated its debt… The difference between the spreads on the two contracts, known as the “basis”, is commonly seen as a measure of a country redenominating its debt. In the current storm, it is clear that the new contracts are in much heavier demand than the old.
What or who can save this? With record high short exposures, the answer – in the short-term – is simple – ban short-sales of bank stocks and BTPs and unleash some massive jawboning from Brussels that The ECB will still do “whatever it takes” – as former fund manager points out, “only the ECB can sound the all-clear klaxon” now. The question is – will they?
Wait for it. Wait for it…
Not for someone to tell you it’s time to fade the extreme moves of the last few days. That was inevitable. It’s amazing how people meting out advice are able to summon infinite amounts of bravery.
Nor the invigorating feeling of debating just how existential, or not, is this latest chapter in the saga of European unity. I haven’t missed that particular one. Made the more so since it goes into periodic remission without ever being cured.
Rather, it was the off-text comment by Bank of Italy’s Governor, or maybe more relevant in this case, ECB Governing Council Member, Ignazio Visco that there is no justification for how markets are reacting to the latest political news other than “emotional” ones.
Odd condescension from a member of the quantitative easing crowd which drove asset prices and peripheral spreads to the unrealistic levels from which they are now fleeing.
There are many hints as to when it might be time to take a shot from the long side. But be careful arguing the intrinsic value of anything until things calm down. There is only one market-maker left who can see every bid they show getting easily filled-in and say, “A pox be upon you. I stand ready to take on all comers.”
And so far the ECB is having none of it either. They’ll be brave again too, one day, but for now it’s, “We will see what happens”.
When they do reemerge, expect them to save face by being brutal about it. It’s their market after all.
So as we wait and watch the accordion-like movement in BTPs and resist suggestions such as, under the circumstances, to sell euro against the now righted Turkish lira, it’s worth revisiting the contagion issue.
Everything is connected.
It’s one big suppressed volatility and rates play. And the only way out at this point is robust global growth.
Call that into question and, while relative plays may indeed exist, it will all be in the context of down markets. What we call “risk-off” rather than “reality bites”. And these are hard trades to choose well and exit elegantly. Follow this sort of trade recommendations with caution. And don’t trade crosses that don’t exist in the real world.
One thing the dollar index chart is telling you is that we really need to stop calling this move “short-covering.” Smart people may have realized that not everything in Europe was paradise up until last week and, push comes to shove, the dollar is still a safe haven. What must that say about the rest of them?
This Friday we will get the non-farm payrolls report. All eyes on work-week details? Maybe. Or it might just turn out that it’s back to the future and we focus most of our curiosity on the G-7 meeting over the weekend. I want to watch the part where the Secretary disavows any knowledge of the Italians’ actions.
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