Italy

Remember when we said (yesterday) that Germany will soon balk over the fact that it is pledging its entire economy to bail out an insolvent Europe? Well, that moment has come.

• German Govt: Italy Too Big For EFSF To Save - Spiegel
• German Govt: Doubts Whether Tripling EFSF Would Help It Save Italy
• German Govt: Italy Must Make Savings, Reforms To Exit Crisis - Spiegel
• Italy Debt Guarantee Could Raise Doubts Over Germany's Finances - Spiegel
• German Govt: EFSF Should Only Help Small, Mid-Size Countries - Spiegel

Here is your chance to see Italy's troubled PM FinMin Giulio Tremonti and even more troubled Prime Minister Berlusconi hold a press briefing on the topic of Italy's economy and market, and attempt to soothe stocks. Judging by the ongoing flash crash across various open markets, they better have something convincing to say.

As both Italian and Spanish bond spreads continue slowly creeping wider toward the half a century territory, we are reminded once again that once both countries pass 450 bps, LCH will automatically hike collateral triggers for both countries, in essence initiating another waterfall effect whereby less cash is released upon repo, requiring more bonds to be pledged, which in turn means other assets have to be sold off to make up for the shortfall, which in turn leads to a sell off of the underlying financial institution (recall that banks in Europe buy their nation's sovereign debt and immediately pledge it back via various repo mechanisms) and so on. What this practically means is that the bond vigilantes now have a far more achievable task in terms of endgoals when it comes to punishing the offending debt, in this case Italy and Spain. Expect a prompt move to this appropriate level as debt holders start panicking what an extra margin demand will mean for them, and in turn try to lock up cash at current repo levels.

The irony about the blow up over the past month in "all things Italian" is that the facts about its sovereign debt and viability profile have always been available for anyone to not only see, but make the conclusion that the situation is unsustainable. The fact that so few dared to do so only confirms that affirmative confirmation bias that dominates within 99% of the investing population. Sites such as Zero Hedge and others had been warning for over a year that the Italian "contagion" (which is a misnomer: Italy's lack of viability is perfectly-self contained: it does not need Greece or Portugal to blow up, and can do so perfectly well on its own, but the punditry certainly needs a scapegoat, in this case the incremental layering of "revelations" about how insolvent Europe is) and we have long presented primary source data confirming just how precarious the house of cards is not only in Italy but everywhere else too. Regardless, no matter how conventional wisdom got to the big picture revelation of just how ugly Italy's reality is (and don't think for a minute that Spain is any better) the truth is that the cat is not only out of the bag, but is widely rampaging through the china store (no pun intended), high on speed and methadone. So for everyone who still wishes to know why the Italian jobs is very much hopeless absent the ECB stepping in an bailout out the country, below is a succinct list of 15 bullet points courtesy of The Telegraph, which explains all there is to know about the country's current predicament. In retrospect we certainly can not blame Tremonti for wanting to get the hell out of there.

Market holiday bitchez. "Further notice will follow." Don't hold your breath.

And so the war against the rating agencies is now official as a floundering Europe does anything in its power to scapegoat anyone and everyone, starting with its natural sworn enemy of course, the rating agencies. According to Reuters, "Italian prosecutors have seized documents at the offices of credit rating agencies Moody's and Standard & Poor's in a probe over Suspected "anomalous" Fluctuations in Italian share prices, a prosecutor said on Thursday." Ah yes, it is Moody's fault that Unicredit, Intesa, Fiat and pretty much all other Italian companies now close limit down at least once a day. Either way, this is sure to end well. We will bring you more as we see it.

When it comes to its opinion on the shape of the bailout, Goldman is a force to be reckoned with (as in every other endeavor, no matter how self-serving the outcome ultimately is): after all it was Goldman which first proposed expanding the EFSF and using it as a "bad bank" SPV which has the extra benefit of being off the balance sheet, and can issue more debt than virtually any financial institution in the world (see EFSF - Too Small? Too Big? Or Just Wrong?). Which is why when Goldman discusses next steps, you can be positive, this is precisely what will end up happening, and that Goldman is already well positioned to profit from whatever policy recommendations it has imposed. So without further ado, here is Dirk Schumacher's latest outlook on how to perpetuate the European status quo.

Q. What is the last thing that panic driven market plunges need? A: The Truth, this time brough to you by the only credible rating agency: Egan-Jones.

• Banca Monte dei Paschi: EJR lowered BBB to BB+ (S&P: A-) (BMPS IM)
• Intesa Sanpaolo SpA: EJR lowered BBB- to BB+ (S&P: A+) (ISP IM)

Italy undergoing a slow motion crash, with bank after bank getting halted, first Intesa, then Monte Paschi, and most recently, main bank Unicredit. The FTSEMIB is now down a whopping 5.5% from intraday highs, led by the financial sector which may or may not last the week absent another EFSF expansion as we have speculated before. Of course, should that happen, Italy becomes a liability and not a funder, meaning the proportional obligations of Germany and France will surge, just as we explained two weeks ago. And more bad news: the spread between the 10 year Italy - Bund just hit an all time wide of 349, +16 bps on the session, as Italy CDS are now trading 328, +12, and Spain is 9 bps wider to 374. Time for bailout #3, this time to rescue Italy, then Belgium and Spain, then France and the UK, until finally the Fourth Reich, in the darkness, shall bind them. 

On the one week anniversary of Europe's second bailout one may be tempted to ask "what bailout" looking at the across the board deterioration in European market metrics: Spanish 10 Year bonds over 6.00% again, Italy CDS surging to 330 bps, Italy Bunds spreads at 331 just inches away from all time wides of 353 bps, EURUSD plunging by over 100 pips overnight, CAC, DAX, OMX all falling by more than 1 standard deviation as VW, chemical maker BASF, and Credit Suisse all missed earnings estimates, and, of course, numerous Italian banks (don't disappoint us UniCredit) once again on the verge of being halted after plunging by a solid 5-6%. Several reasons for the weakness: i) Italy auctioned off €8 billion in 3,4,7,10 and year fixed and floating rate notes generating weaker than expected results with the 10 year bond gross yield rising to 5.77%, the highest since 2000, and just under the all time record of 5.81%, and the 3 year gross yield of 4.80 pushing to the highest since 2008, ii) more rumors of Tremonti resigning, iii) European retail sales declining for a third month according to Markit, and iv) a decline in Euro-area economic confidence more than estimated, dropping from 105.4 to 103.2, below the consensus of 104.0. German bunds are once again well bid with September futures rising 0.2% to 129.63. But not before rumors of ECB buying peripheral bonds via the SMP spooked bunds lower, with the resulting rise being only a result of the flight from Italy. And putting a cherry on top of it all was ECB's Mersch who once again resumed the old party line, saying that fears of a "premature end to euro are unfounded." And to think that just a week earlier the ECB told us we would never have to worry about the end of the euro.

When we looked at the notional change in net outstanding CDS on the top 25 reference entities tracked by DTCC last week, we first made the discovery that the US has for the first time surpassed Greece in number of net speculative default bets outstanding. It was, also, the most rerisked name in total monthly notional, outpacing China and Japan in second and third place. Following tonight's weekly update from DTCC we get an even starker picture of where America lies on the risk spectrum: just to the left of UniCredit and Italy (left being bad). As the chart below indicates, the monthly percentage change in the number of net CDS contracts outstanding on the US increased by a whopping 10%, beating such insolvent entities as Italy's top bank and Italy itself (with mega black swan China, and 200% debt/GDP Japan coming in 4th and 5th place). And completing the bad news for the US from the perspective of a CDS trader, is that for the first time ever, US 1/5 year CDS inverted. Why? Because with American recovery rates well in the 80s based on trading prices of the cheapest to deliver bonds, unlike other sovereigns such as Greece which may need recovery calcs in the 20s or 30s, this is virtually equivalent to trading points up front and convexity is massive. It also means that with the 52 week Bill pricing at 0.2% earlier today, anyone who wishes to transact in a 1 year basis trade, can make a lot of money by putting on the negative basis courtesy of the blow out in 1 Year CDS compared to cash... assuming the US does not default of course. But in that case one will be bigger problems than paying their counterparty the require variation margin.

Citing the most hilarious explanation we have ever heard for not daring to approach the capital markets, Dow Jones reports that following a comparable announcement from Austria earlier, none other than clutch euro Domino Italy, whose bond yields surged by about 40 bps today, has decided to take a sabbatical from accessing capital markets, and will not issue medium and long-term bonds in August. Of course, the real reason is that the spreads are prohibitively high but that's a story for another reason. The problem for Italy, however, is that it will end up burning through a lot of cash over the next 45 days and then far more will depend on the successful passage of the country's auctions in the following month, when the next scheduled medium term auction is on September 13 (full auction schedule is here). Amusingly, while all of Europe complains that the Greece, Ireland and Portugal have no capital markets access, some of the better of PIIGS make the voluntary decision to avoid price discovery. We fail to see how this can possibly result in anything than another loss of credibility in the eurozone rescue package.

Over 3 weeks ago, before Italian treasury spreads blew out by several hundred basis points, and before Italian bank stock trading halts became a daily occurrence, we suggested that the European contagion was shifting to Italy based on Goldman dark pool Sigma X trading. To wit: "Today's most active names are Banca Monte dei Paschi di Siena, Unicredit and Intesa Sanpaolo. Translation: someone is actively positioning for serious action in Italy shortly." That someone sure was right, and it is precisely this trifecta of stocks that at last check was halted on the Borsa. Well, based on today's action at Sigma X, the next, and probably biggest domino may be about to fall: the UK itself, because coming in at position #2, just behind UniCredit, we see Lloyds Banking. And if Lloyds goes, the ones that will follow are Barclays and RBS. At that point, the financial crisis goes global.

It's getting very scary out there. First there has been an unsubstantiated rumor that Spanish PM has resigned based on an El Pais editorial, and then we have the fact that Greek 2 year bonds have just collapsed by another 2% to an all time record 35.19%. The cherry on top are reports that Intesa Sanpaolo and some other volatile bank shares are suspended after continuing their last week plunge. One day soon the entire European stock market will just shut down and not reopen (which will naturally simply be an excuse for the US HFT lobby, which now feels unfairly attacked for being a malicious parasite, to levitate the Russell 2000 to unseen levels).

While it is unclear if the ECB intervened in the second Italian bond auction of the week (we will know better over the weekend when the ECB provides the weekly change in its bond purchasing program), the much anticipated issuance of 5 and 15 year bonds is now in the rear view mirror. As Reuters says, "Italy sold almost 3 billion euros of medium- and long-term government bonds on Thursday in a sale which analysts said went well although the Treasury had to pay the highest premium on record to sell 15-year paper. The gross yield on the 5-year BTP jumped to 4.93 percent, the highest yield in auction since June 2008 and compared with 3.90 percent in the last auction a month ago. The new 15-year benchmark drew bids 1.49 times the amount offered and a gross yield of 5.90 percent, the highest on record. The auctions were seen as a key test of market appetite for the country's debt after it got sucked into the debt crisis, sending its benchmark 10-year yields briefly above 6 percent on Tuesday for the first time since the euro's launch in 1999." The prior 5 and 15 year bonds priced at 3.90% and 5.34% respectively, and 1.28 and 1.33 for the Bid To Cover. Yet with the 15 Year trading at 5.99% just prior to the auction, it does seem that there was a positive surprise. We will bring you any stories of ECB or Chinese intervention as we see them.