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Italian Risk Still Dominated by Fiscal

01 June 2020 by jbchevrel

Italy’s increased funding needs due to COVID and lackluster non-domestic demand have been offset by the new European Commission €500b proposal last week, bringing game-changing common issuance concept on the table. This recent development has given the market more conviction about intra-EMU spread convergence than the previous PEPP, whose impact had been partially offset by the GCC ruling on the PSPP. The perception of more official fiscal union features (common debt issuance, by the EC) as opposed to non-official (ECB deviating from Capital Key in PSPP + no Capital Key in PEPP with no communication whatsoever) is very positive and argues for compression. In financial CDS space, this has been expressed by the continued outperformance of Italian banks. The consensus view seems to be that while we may see corrections in this trend tighter, possibly occasioned by opposition from some of the most fiscally conservative countries in the EU council (‘Frugal 4’), it is harder to argue for a reversal of that trend. Today’s MNI story also falls under that category. The expectation of the market ahead of Thursday’s meeting might have been a bit too optimistic. To recap the COVID move, using Intesa: ISPIM senior CDS went from 63bp to 253bp before reverting to 130bp area. This is a c65% retracement and is to be compared with c75% retracement for SnrFin index. ISPIM subordinated CDS went from 159bp to 586bp before reverting to 333bp. This is a c60% retracement and is to be compared with c75% retracement for SubFin index. ITALY 5y CDS went from 100bp to 260bp before reverting to 192bp. This is a c43% retracement. In CIS space, senior financial index has converged to about 10bp above Main. Within financial CDS space, UK names have been underperforming over the past few sessions, both Asia-focused and UK-focused ones. It was reported that the EU fears that the UK government is deliberately stalling on Brexit trade deal negotiations and may secretly be aiming to exit European trade arrangements without first agreeing a new deal. The UK is due to exit Europe's trade and customs arrangements at the end of 2020, despite growing pressure from business groups and opposition political parties to extend the Brexit transition period. The UK government meanwhile insists that the UK will leave, regardless of whether a new trade deal is negotiated. Get Brexit Done, in case that rings a bell. There is time for this UK/EU situation to get worse before it gets better, if it does, eventually.