If ECB can not cause any more spread compression in Italy and in EUR periferia bonds in general, then what would?
Simply look at the left side. Weekly chart start to look horrible. I see a huge bowl, which will soon start to boil! setup is turning towards . How can it be? Just look back and see how it was! Same can happen on the side later this year. When I say , that means for the bond spread, a much higher yield over German Bund , so basically very for Italian 10y bond.
The key yield spread level is very close! If it trades over 135-140 bps , Italin bonds will blow up, and the spread can easily go out to 255 bps! If some really big sht happens in Italy during the referendum they have in December, than the spread will blow to 340 bps , or even higher. Just remember how Greece was trading when they had possible situation to leave the Euro zone.
Some more fundamental thoughts:
1. Italy in general have a huge structural problem in their economy. While even Greece, Portugal and Spain managed to stabilise somehow their economies during last five years, Italy has not really achieved much. They stopped their fiscal deterioration, put serious control on tax revenues, but could not execute any major structural reforms.
2. Italy's debt to GDP is one of the biggest in the world. Debt level is over 132 % (!!!) of their gross domestic product, and no chance it could be cut any time soon.
3. They have a serious crises in banking system. In fact their whole zombie banking system is absolutely bankrupt, it's only the ECB who backs them and keep it alive. And guess who is holding the most of their huge debt, so their bonds? Of course their own banks.
4. Thes have always had their political turmoils in last 5 years. They might have another one this year too. PM Renzi called for a referendum, which will take place in December. This is about to open door for reforming the political systems (mainly about the veto right of Senate), and an absolute key to get athorization for economic reforms.
In case of a failure, the Government will step down, new elections will take place, where most likely EUR sceptic right wing could have high chance to win.
5. Now tell me how fckd up a bond market can be, where Italy's debt is valued less risky than USA??? I mean if you look only at the nominal spread of US10y/Bund and IT10y/Bund, those are appr. 170 bps vs 131 bps . :-) short term it looks funny, but long term it must be a bad joke. This is how much Central Banks' manipulations fckd up the bond markets valuation. Of course in case there will be the slightest chance Italy could fall out of EUR zone, this insanity will quickly normalise.
6. Finally think about what do you hold when you buy a German bond, and what do you hold through an Italian debt. Think in options! If you have a German 10y bond, even if you have negative yields, that contains a CALL option for , in case somethiing really mad happens and Eurozone blows up. On the other side, if you own Italian 10y (or any other maturity) bond, there you have an ITL (Italian Lira) exposure. When you buy German Bund and sell Italian BTP over it, your synthetic option will be: Long Call + Long Put ITL = Synthetic Long forward DEM/ITL.
How much do you think a DEM/ITL cross would move up after an Italy-Exit? Just try to compare it to USDRUB , USDTRY , USDZAR moves. My guess is the ITL depreciation would be minimum 50 %, if not 75%.
Obviously you pay the cost of holding this option through the difference between the yield curves roll downs and the forward yield spreads.
Should you have any questions or views in this topic, I am happy to discuss any time.