When it comes to the latest rout in Italian bonds, which has continued this morning sending the 10Y BTP yield beyond 2.40%, a level above which Morgan Stanley had predicted fresh BTP selling would emerge as a break would leave many bondholders, including domestic lenders with non-carry-adjusted losses…
… there has been just one question: when does the Italian turmoil spread to the rest of Europe?
One answer was presented yesterday by Goldman Sachs which explicitly defined the “worst-case” contagion threshold level, and said to keep a close eye on the BTP-Bund spread and specifically whether it moves beyond 200 bps.
Should spreads convincingly move above 200bp, systemic spill-overs into EMU assets and beyond would likely increase. Italian sovereign risk has stayed for the most part local so far. Indeed, the 10-year German Bund has failed to break below 50bp, and Spanish bonds have increased a meager 10bp from their lows. This is consistent with our long-standing expectation that Italy would not become a systemic event. That said, should BTP 10-year spreads head above 200bp, the spill-over effects onto other EMU sovereigns would likely intensify.
Well, as of this morning, the 200bps Bund-BTP level has been officially breached. So, if Goldman is right, it may be time to start panicking.
Ironically, almost as if on cue, just as the Italy-Germany spread was blowing out, a flashing red Bloomberg headline hit, confirming the market’s worst fears:
- SPANISH SOCIALISTS REGISTER NO-CONFIDENCE MOTION AGAINST RAJOY.
This confirmed reports overnight that Spain’s biggest opposition party, the Socialist Party or PSOE, was pushing for a no-confidence motion again Spain’s unpopular prime minister. The no-confidence call follows the National Court ruling on Thursday that former Popular Party officials had operated an illegal slush fund, as a legal result of which 29 people were convicted and sentenced to a total of 351 years in prison.
While Spain’s anti-establishment party Podemos has already called for a Raoy no-confidence vote, the Socialist Party joining that call makes it that much more likely, but just the two parties still do not guarantee Rajoy’s exit, and a successful outcome would depend on the participation of market-friendly party Ciudadanos, Spain’s 4thlargest party.
Well, following this headline, Rajoy’s political future suddenly appears to be over:
- CIUDADANOS WILLING TO BACK NO-CONFIDENCE VOTE AGAINST RAJOY
Which means that, while independent of the Italian bond rout, Europe’s political crisis may very soon have not one epicenter, but two: Rome and Madrid.
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