We have discussed this a few times over the last year and as Greece begins to show signs of defection, it is perhaps worth considering what a spoiled and chided sovereign might do in a temper tantrum. Peter Tchir, of TF Market Advisors, puts it best this morning: "Everything I have read over the past couple of weeks coming out of Italy, tells me that if there was one country prepared to "screw" the Euro and go it alone, it would be Italy. They don't like Merkozy treating them like children, and they have a big enough economy that a dirt cheap Lire would make exports possible".
Italian 5 year bond yields hit 6.24% that is 37 bps higher on the day. The spread to bunds moved 56 bps. 10 year Italy "only" yields 6.32% - that is getting scary flat. The front end isn't as flat, but 2 year Italian yields spiked to 5.5% (55 bps on the day).
If Thursday didn't teach us that you can't let price action tell you whether a "grand plan" is good or not, I would watch this very carefully. Yield curve flattening is a big deal and a critical step in the deterioration of the credit worthiness of an entity (the 1st loss from the EFSF may be gaining in value, but who wants the more and more likely 2nd loss?).
I once again would be concerned about getting too short Italy via CDS. It looks like Italy could re-denominate the debt (as a G-8 country) back into Lire and it would NOT be a CDS Credit Event. It might be a lot of other things, but Credit Event is not one of them. Everything I have read over the past couple of weeks coming out of Italy, tells me that if there was one country prepared to "screw" the Euro and go it alone, it would be Italy. They don't like Merkozy treating them like children, and they have a big enough economy that a dirt cheap Lire would make exports possible, and while foreigner bond holders might lose on a forced convergence to Lire, Italian banks and pension funds could at least pretend they are getting paid in full. China did send delegates to Italy not so long ago, if I remember. Maybe it wasn't part of a save Europe project, as much as it was a what bargains can we find in Italy trip? A really strong Deutsche mark might not even both export oriented China as it would make German goods less competitive at the time China is trying to step up their manufacturing to a higher level of quality.
Germany may regret wasting the last 18 months trying to save the Euro and not doing enough to save themselves.
This scenario is clearly far fetched, but if we are going to think out of the box, not every possible outcome is good. And this would be good for Italy and China.