As traders arrive at their desks this morning across America, one could be forgiven for exclaiming "I love the smell of relief rallies in the morning" as Italian bond yields are lower and Italian bank stocks are not tumbling (for the first time since Five-Star and The League joined forces)...
...and US equity futures are holding gains (from yesterday's Trump Trade Truce)...
...suggest that the indestructible market mantra that "bad is good" and "buy the dip" is back.
There's just one thing...
The Italian crisis is far from over and the concept of their 'mini-BoT' parallel currency is throwing up some very red flags about the future of the European Union...
You just have to know where to look.
As Bloomberg's Tasos Vossos notes, a gauge of euro re-denomination risk (based on the so-called 'ISDA Basis' in Italy's credit default swaps) blew out.
What's more, redenomination risks are spreading as the measure widened in Portugal, Spain, and in France to a lesser extent, according to CMAN data.
As parallel currencies and debt-cancellation become serious discussion points for an Italian government, so European break-up risk is resurging.
Simply put, the higher this chart goes, the lower the market 'values' an Italian Euro relative to say a German Euro... and thus it is measuring the risk that the European Union - so long defended by Draghi et al. as indestructible - will break up.
As Marcello Minenna, head of Quantitative Analysis and Financial Innovation at Consob - the Italian securities regulator, previously noted, "markets do not lie... Italy must avoid remaining with short end of the stick. I wonder if our leadership will rise to the challenge."
While the European Central Bank’s commitment to defend the irreversibility of the euro is based as much on threats as on positive pledges, financial markets understand the risks of "Italeave" even if the likelihood of the event is still judged to be low.
This can be seen in the data on credit default swaps (CDS), which offer protection in the case of an “insured event” or, in the jargon, a credit event. The widening gap in prices between different types of CDS contracts reflects the rising risk that some euro area sovereign debts may be redenominated into new, depreciating, currencies, which would probably lead to real losses for investors.
To correctly interpret the data on CDS prices, we need a quick flashback to 2012, another year of great tension for the single currency. While the center of the crisis was in Greek sovereign debt and the Spanish banking sector, institutional investors had already begun to think of how to protect themselves from the danger of the euro’s total dissolution, which might be prompted by the exit of a big country such as Italy or France.
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