Et Tu, Italy?

CAESAR - Et tu, Brute! Then fall, Caesar! [Dies]

CINNA - Liberty! Freedom! Tyranny is dead!
Run hence, proclaim, cry it about the streets.

CASSIUS - Some to the common pulpits, and cry out
'Liberty, freedom, and enfranchisement!'

BRUTUS - People and senators, be not affrighted;
Fly not; stand stiff: ambition's debt is paid.

("Julius Caesar" by William Shakespeare, Act III, Scene I)

Things just got interesting – maybe. It is hard to write anything definitive given how quickly events are unfolding. Investors were taking turns being spooked by possible trade wars, cancelled (but now rescheduled) Korean denuclearization summits, and elevating unrest in the Middle East. The US market continues its volatile tug-of-war between heavy fiscal stimulus and tightening monetary policy. Interest rates and the US dollar finally started to act the way we’ve been expecting them to (rising and strengthening, respectively), causing a “risk off” run in many EM assets.

And then along came Italy. The populist and left-leaning 5 Star party attempted to form a government with the nationalist, anti-establishment, and right-leaning League party (with both parties being anti-Eurozone), only to see the Italian President Sergio Mattarella block that formation and reject the coalition’s choice for Economic Minister (Paolo Savona, who was viewed as being far too much of a Eurosceptic). Those two parties will now try to re-form a workable coalition, or Italy will need to have new elections, and the concern is that populist and/or anti-Eurozone activists will gain power. As Europe’s third largest economy (behind Germany and France), the thought of Italy leaving the Eurozone is simply intolerable to the markets, and they reacted violently.

Italian short-term bond yields and spreads to German Bunds skyrocketed, investors rushed into save haven investments like the yen and US Treasuries, and European banks and financial firms took it on the chin. After grinding higher through most of April and May, US Treasury yields collapsed to levels not seen in months as investors rushed to “de-risk” their portfolios. The corresponding boost to the dollar exacerbated the sell-off in Emerging Markets. We witnessed an overall level of market panic that we have not seen since the Greek financial crisis that began in 2010, amplified by the comparative size and importance of the Italian economy relative to Greece.