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Mamma Mia

16 May 2018 by lberuti

A draft of the governing contract between M5S and the League was leaked last night. While it was later dismissed as a previous draft, fully superseded by now, it was dated 14th May and gave a taste of a number of key issues. The least that can be said is that market participants found it disturbing. It included controversial topics such as debt cancellation and a procedure to allow member states to leave the Euro. While apparently deleted in subsequent drafts, the mention of the creation of a mechanism for a potential Italexit gave the sense of a coalition ready to reignite the redenomination risk. On the debt, it was suggested that the ECB should cancel the Italian sovereign bonds it currently holds. The idea is that this debt is neutralised as the interests paid to the Central Bank are reverted to the Italian government, and as such the cancellation would have little impact at least until ECB’s policy of reinvestment holds. This idea – which Charles Ponzi once found quite interesting – suggests that the M5S-Lega coalition would consider the non-repayment of a debt to the ECB. It did not go down that well with markets when Greece floated a similar idea a few years ago… It sent the BTP-Bund spread flying – it closed 21bps wider – and put everything Italian under pressure. Of course, most of the pain in creditland was inflicted to financial institutions, and if you click on the Financial bubble in the above grapple, you will see that the 5-year risk premia of UCGIM (UniCredit SpA) – 7bps wider at 82bps – and ISPIM (Intesa Sanpaolo SpA) – 7.5bps wider at 86bps – were the clear underperformers of the day.