Italian Bonds, Ray Dalio's Bet & The Eurozone

The Italian bonds have plummetted in the past week or so and by now every barber, trader, finance grad seems to be an expert on Italian politics.

I will not bore you with the same the details, which you've probably read by now. Let me just fancy you with some charts and insights I gathered via various sources to save you some time and provide meaningful insight.

The yields speak for themselves, it always sounded absurd to me that Italy with all its political turmoil and financial risks is able to borrow money at a rate of 1.7% (last auction) which is significantly lower than the U.S govt's cost of 3%. Italy has had NIRP(Negative Interest Rate Policy (https://www.worldgovernmentbonds.com/bond-historical-data/italy/2-years/) for a while due to ECB's QE (ending in sept) which means people are actually giving money for the privilege of lending money to the Italian government? Let that sink in.

Now some say, no worries, Italy being the third largest economy in the eurozone, the ECB will intervene and save the day quoting #TooBigToFail. However, the ECB has its own conditions, the anti-establishment parties that may/may not form a coalition want to cut taxes, increase spending and look for the alternative currency, but, this is completely the opposite of ECB's austerity view.

ECB Vice President Vítor Constancio, “I would like to stress that every intervention has to contribute to the fulfilment of our mandate and is also subject to conditionality. The Outright Monetary Transactions program for intervening in national sovereign bond markets of vulnerable countries can only be used if the country in question also agrees to an adjustment program. The rules are very clear on this. Everyone should remember that.”

Now the other camp claims Italy has become #TooBigToRescue or is it?

Here you see, Germany's claim on assets is approx $1 Trillion, out of which Italian bonds and assets are upto the tune of $426 billion. Do you really think the ECB will let that slip? No. Do you really think Italy will drop the Euro? Probably not.

1) Bond market moves do not break up monetary unions. Bank runs do. There is no evidence of bank runs.

2) Neither Italian parties nor Italian voters support leaving the Euro.

3) The anti-party coalition was not expected to last, because of policy disagreements. It is not certain that the two anti-parties would try to form a government after elections. (via Paul Donovon, UBS)

So everyone needs to calm down for now and watch closely. But, guess who shall not calm down and get really excited, laughing his way to the bank? Ray Dalio!

Bridgewater Associates, the world’s largest hedge fund ($160B AUM), has ramped up its short positions in European equities in recent weeks, bringing their total value to an estimated $22 billion. The Westport, Conn., company, founded by Ray Dalio, has shorted companies that range from German industrial conglomerate Siemens and automaker Daimler to French oil giant Total and Italian bank Intesa Sanpaolo.

Here's a look at Intesa Sanpaolo's stock: The stock is at trading at 1-year lows now, dropping as much as 25% in a month. Now you wonder why?

Here's why.

A recent study by the Bank for International Settlements shows Italian government debt represents nearly 20% of Italian banks’ assets — one of the highest levels in the world. In total there are ten banks with Italian sovereign-debt holdings that represent over 100% of their tier-1 capital (which is used to measure bank solvency), according to research by Eric Dor, the director of Economic Studies at IESEG School of Management.

The list includes Italy’s two largest lenders, Unicredit and Intesa Sanpaolo, whose exposure to Italian government bonds represent the equivalent of 145% of their tier-1 capital. Also listed are Italy’s third largest bank, Banco BPM (327%), Monte dei Paschi di Siena (206%), BPER Banca (176%) and Banca Carige (151%). (To read more on the "doom loop" of Italian banks: https://wolfstreet.com/2018/05/27/which-banks-are-most-exposed-to-italys-sovereign-debt-other-than-the-horribly-exposed-italian-banks/)

That's it for now. Thank you for reading!

Data Sources:

https://www.worldgovernmentbonds.com/bond-historical-data/italy/2-years/

https://wolfstreet.com/2018/05/30/ecb-reacts-unofficially-to-nirps-revenge-in-italy