Italy’s yields have led wider havoc in the eurozone government bond markets, with swap spreads bouncing all over the place and issuance all but impossible for most borrowers.
While the spark is easy to pinpoint — President Sergio Mattarella’s decision to appoint a technocratic government rather than a populist coalition of the Five Star Movement and the League means more political uncertainty in the country over the coming months — the accelerant of the bond fire has older roots.
Regulations introduced since the 2008 financial crisis have limited banks’ ability to provide balance sheet support to squeeze in bid/offer spreads during times of trouble — a definition which certainly includes this week.
Over the last few years, eurozone governments have been able to rely on the friendly sight of the European Central Bank’s quantitative easing programme taking the sting out of any big moves.
The ECB could still step in on Italy, of course — its QE programme will run until September at least — but it has already started pulling back. In January, it halved its monthly purchases to €30bn.
As one SSA syndicate head put it, the fact that balance sheet availability for traders has shrunk “Street-wide” has not really mattered over the last few years thanks to QE, “so whatever you bought you could recycle”.
But this week, “we have a situation where QE is being reduced, balance sheets are very small and there is a truckload of sellers”.
A mob of investors rushing for the exits was one thing before the crisis, when banks could afford to take their unwanted paper, or afterwards, when the ECB stepped in with an offer to snap up just about anything going.
The ECB hasn’t disappeared completely, Italy is far from political collapse and its bond spreads are well off the wides we saw during the eurozone sovereign debt crisis.
But in this new world of normalising monetary policy and dwindling balance sheet support — not to mention rising populism — we should expect more violent weeks like this.
