A recent trip to Milan left me with one abiding memory: the way in which nobody at all seems to be flapping over the outcome of Sunday’s referendum.
The overriding attitude seems to be a shrugging of shoulders and the acknowledgement that “Alora, there goes another government”.
Italy has for decades, in one form or the other, lived with political and economic crisis. The Candidian response that it will be fine in this, the best of all possible worlds, is deeply engrained in the culture. Thus it is that the € 5bn capital shortfall which has Banca Monte dei Paschi di Sienna – nicknamed Monte de Dead Parrot by one market man I know - knocking at death’s door looks as though it might be resolved before the end of the year by the government taking up a very significant issue of deeply subordinated bonds. Would this be in contravention of EU state aid rules? You bet it would but when faced with the risk of losing one of its largest banks or facing the paper tigers in Brussels, the Italian government knows exactly what to do.
The incredibly sanguine response by markets to the referendum displays, in my opinion, an acknowledgement that rules are here to be bent and that in order to maintain the single currency project, members will increasingly be permitted to step out of line from time to time with little more than vocal risk but without fear of being swamped by sanctions. Let’s face it, the European Union has a long history of disregarding its own rules when convenient. Through the 1990s, the French illegally propped up one failing state enterprise after another and never seriously got taken to task. Italy will surely follow suit: subsidise and be damned.
From their recent pre-referendum peak of 2.13%, Italian 10-year bond yields dropped to 1.90% and are, at the time of writing, marked at 1.92%. As recently as November 28, 10-year Italy was trading at 192bp over 10-year German. As at this morning, that spread is at 155bp. Buy the rumour, sell the fact, or nothing is eaten as hot as it is cooked? Maybe it is simply book-squaring and profit-taking ahead of year end and maybe BTPs will be in the firing line again at the beginning of January. I doubt it. St Mario has made it perfectly clear that he will not let European markets be disrupted and only fools would want to take on the ECB; those who have tried it have generally been carried out on stretchers.
Boomtown
Meanwhile, there seems to be nothing that can stop the US economy. October factory orders and durable goods orders both beat expectations, which had not been modest to start with, and these are figures reflecting pre-election activity. Looking at these and adding the Trumpanomic boom that markets seem to be anticipating and pricing in, I can only see a Fed beginning to fear overheating. It was Larry Summers, former Treasury secretary and now president of Harvard who famously observed that “Things take longer to happen than you think they will and then they happen faster than you think they will”. Markets are sanguine with it having taken 12 months for the Fed to tighten another 25bp – working on the basis of an absolute certainty that they tighten next week – but I fear that they are still significantly underestimating the speed at which the FOMC might move next year. My base case of four moves of 25bp or 1% on Fed Funds over the next year should probably be treated as erring on the conservative side and for choice would probably be a better seller than buyer of my own forecast.
Oil, in the meanwhile, is trading through one head and shoulders formation after the other and is currently sitting on an interim neck-line. Sticking with WTI prices rather than mixing and matching at will with Brent, we are currently at US$51.03 per barrel. Unless it breaks again above US$51.08/bbl, it risks dropping back below US$50. That price is not of itself technically relevant but it will certainly get the media excited. Nothing serious on that front until US$49.08.
Dollar/yen remains on a one-way mission. It continues to cut through technical chart points like a knife through butter, which says a lot about how markets value President-elect Donald Trump’s economic assertions as opposed to those of Abe-san.
Apropos the Donald. I wonder whether he’s simply comparing Air Force One with his own jet - has he not grasped that it is a flying White House? The counter question is whether he might have be ahead of the game and that governing the US is much simpler than we have been led to believe and that the entire process is over-institutionalised. I shall take no stance on this – I don’t know enough about the details – but the question is one which has to be posed. Back to René Descartes and the application of systematic doubt.
Finally, I heard the sad news yesterday of the passing of one of my former colleagues, Neil Morris. Neil, or “Zippy” to the Street for his enormously broad smile reminiscent of that of the children’s TV character on Rainbow, was a trader of supreme mental capacity that was often missed as it was hidden behind a clear and utterly authentic Cockney accent. Zippy is the only trader I have ever seen put on strategic reverse asset swap. There was a supranational sterling bond – I think it might have been for the EIB – which was in short supply and very rich to the curve. The Zippster decided that the issuer would have to reopen the issue but at Libor levels more or less commensurate to the credit and certainly not as tightly as where the existing issue was trading in the market. Thus he put on a further, fairly adult short position, hedged it with a swap and waited for the EIB to fill him. An unforgettable stroke of genius! I can’t imagine what hell would break loose nowadays if a trader began to further short a bond which was already trading 20bps through fair value.
Zippy was one of the coolest guys around, enormously humble but, to those who knew him, with absolutely nothing to humble about.