The Italian debt saga continues with EU intensifying the rhetoric versus Italy. The entire situation is, not overly surprising, a classical Med mess and quick fixes are not to be expected. Per Bloomberg:

The Brussels verdict ratchets up pressure on a coalition government already buffeted by financial markets and plagued by tensions between the anti-establishment Five Star Movement and the anti-migration League. The two allies, however, share a determination to start fulfilling election promises on welfare benefits, a lower retirement age and tax cuts.

Italian bonds rose on Wednesday, with yields on 10-year notes dropping by 8 basis points at 12:30 p.m in Rome, on speculation that the Italian government could agree to revise its budget plans for 2019.

Deputy premiers Luigi Di Maio of Five Star and Matteo Salvini of the League have steadfastly stuck to targets for a 2.4 per cent budget deficit and 1.5 per cent economic growth next year that have irked the commission. In the latest dispute between the allies, however, League lawmakers in the lower house voted with the opposition on an anti-corruption proposal late Tuesday, a defeat for the ruling coalition.

Bloomberg explains further the procedure should things go out of hand with the below image.

Noteworthy in today’s price action is the rather big move lower in the 10-year yield as well as the big reversal yesterday. 3.5% is a big psychological level to watch. Note the 50 day at 3.3 as well as the longer-term trend line.

Italian banks have been hammered for a long time. The index is up 1,5% today, but the longer-term chart is horrible. Do note we are closing in on huge support levels where Italian banks formed a bottom formation in 2016.

The MIB index continues being one of the relative underperformers in Europe, but note the index is approaching big support areas around the 18k level.

Beyond the “normal” global risks, Europe remains under siege by the Italian situation as well as the Brexit soap opera. One of the best proxies for European risk is the credit market, often over watched by equity folks. Watching iTraxx main has been important over the past months.

We have had several opportunities to play equity market direction and volatility views (as well as more complex pairs trades such as long protection via credit versus Eurostoxx futures) by keeping track of the iTraxx closely.

Below is a chart of the Eurostoxx 50 futures versus the iTraxx (white and inverted). They tend to move in tandem, but every now and then they “dislocate”. Note how the recent gap in early November, where credit traded too optimistically, reversed quickly and blew out (bear in mind the curve is inverted). It took the equity market several days to catch up to the sharp adjustment in credit.

This has now “come in”, but we will continue watching any possible dislocation coming up so stay tuned!

Source: charts by Bloomberg