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The latest clash between Rome and Brussels, which erupted over the handling of a ship transporting migrants moored in Sicily, has investors worried that given the tensions, Italy is on track to break the 3% budget deficit limit imposed by the EU when it presents its 2019 budget this fall.
Greece Style Drama Building in Italy
Italy vs. German 10-year bond yield spread is NOW through the Memorial day weekend wides, what a way to end the summer. The VIX Chicago Board Options Exchange Volatility Index touched 17 during the late May drama out of Italy, compared to less than 14 today.
Deputy PM Luigi Di Maio stated that Italy would withhold funding to the EU 28 bloc next year unless other member states accepted the migrants. The European Commission dismissed the threat, stating that the Union “operates on the basis of rules, not threats.” The new Italian administration uses unusually aggressive statements to move towards its policy goals, which may portend to upcoming budget talk negotiations. Investors in the Italian bond market anticipate a possible market turndown and yields across Italian government bonds show significant volatility. After recovering from an 8 basis point slump on August 28th, the Italian 10-year government bond yield sank 6 basis point in one day on August 29th. On the other hand, the Italian government downplays the possibility of wider market selloff, stating that the country will maintain the agreed debt-to-GDP ratio on a downward path. However, the yields across the Italian government bond yield curve are higher than they were a month ago, when ECB chief Mario Draghi warned Italy that the ECB would not adjust its policy to allow for a more spending oriented Italian budget.
A Rare Refusal
European Commissioner for Budget Guenther Oettinger stated in response to the Italian administration that the move would make Italy the first member state in EU history to refuse to pay budget contributions: “This would result in late payment interests. And a breach of Treaty obligations leading to possible further heavy sanctions,”Oettinger responded. ACG Analytics foresees the Lega-M5S administration adopting a rigid line against Brussels in an attempt to bend fiscal target rules this fall.
On September 27th, the government will present its budget update note, followed by the presentation of the budget draft on October 20th. The European Union is also expected to give its opinion on the budget draft in October. Regional elections in Trentino Alto Adige will be held on October 21st and in Basilicata in November.
Cost of Default Protection
As the cost of credit default protection exploded higher on Italian banks in late May, the Five Star Movement’s (M5S) Luigi di Maio and Lega’s Matteo Salvini reached an accord on their coalition’s program. Likewise, the structure of a future cabinet and the candidate for the premiership were on the “Italy First” agenda. Over Memorial Day Weekend, discussions took a sharp turn for the worse as all sides failed to agree on a new finance minister. Some in Lega party leadership insisted on a Euroskeptic head of finance, others want a more centrist figure. Together, the M5S and the League (Lega) have an impressive majority of 37% in the 630-seat Chamber of Deputies, though a slimmer edge in the Senate. Their standing is up over 200% in recent years as the Populists have been able to steal political market share from center-left parties in Italy. See our The Bear Traps Report with Larry McDonald; Tocqueville’s Italy – January 25, 2018_