The blistering rally of Italian equities and sovereign bonds is a marvel to behold. Short-covering rallies are always the most glorious, and the most treacherous.
The market bounce after Brexit made perfect sense. Half the world immediately loosened policy to cushion an imaginary shock.
It even made more sense after the election of Donald Trump. His triple pledge of tax cuts, a building boom, and an imperial navy – if enacted – will flood the US economy with even greater fiscal stimulus than Reaganomics.
But it is hard to conjure any plausible story to justify a happy outcome from the turbulent events in Italy, at least for the holders of capital. „Nothing has changed for the better. You cannot find anything fundamentally positive about the referendum result,“ said Lorenzo Codogno, former chief economist of the Italian Treasury and now at LC Macro Advisors.
„The whole world was short Italian banks, and everybody jumped to cover at the same time. That is what is this rally is about,“ he said.
The government of Matteo Renzi has collapsed. The Italian establishment has suffered an earthquake defeat, more like the enveloping Bourbon downfall of the late 1850s than anything that has occurred in recent Italian history.
The electoral laws are in chaos. A once unthinkable Left-Right alignment of anti-euro parties is emerging with a real shot at power, perhaps as soon as early spring if the country’s president allows a snap vote.
We could then have the spectacle of back-to-back elections in Italy, the Netherlands, and France, each dominated by the overriding theme of regime change and each posing an existential threat to monetary union. The tail-risks are colossal.
The Italian Treasury is preparing a „precautionary recapitalisation“ of Banca Monte dei Paschi di Siena (MPS) for €2bn, a sign that a private deal with Qatar and Anglo-Saxon funds has broken down. Turning this into a bullish event takes imagination. What it surely means is that nationalisation is closing in on a string of Italian banks.
Yet the Milan bourse has surged by 7pc since the constitutional referendum went down in flames. Monte dei Paschi itself has jumped 15pc on the fumes of optimism, buoyed by a stay of execution from the European Central Bank.
Markets seem to be betting that a rescue by the Italian state – now thought imminent – will avert the worst of a bondholder „bail-in“ under the EU’s draconian new rules.
No doubt there is a straw of sorts to clutch in this convoluted story. Article 32 of the Bank Recovery and Resolution Directive (BRRD) allows some flexibility in cases of systemic risk, and the calculus is that the EU is so alarmed by the scale Mr Renzi’s defeat that it will bend all rules. Italian banks will breath again.
Italy’s biggest lender Unicredit is up 25pc in this froth of excitement, and never mind a non-performing loan book of €84bn and a capital shortfall of €9bn that must be plugged.
Mr Codogno said the fond hopes of investors will be dashed soon enough. „It is wishful thinking. The banks still have to abide by EU state aid rules and that means a bail-in,“ he said.
The dominoes will fall, and each one will cause a political storm. Some savers duped into buying junior bank bonds may be reimbursed one day: first they will suffer. Those who bought through pension or mutual funds will get nothing.
The corrosive effect will eat away at the credibility of Italian political order. Any attempt to put off the vote of reckoning until 2018 by recourse to a technocrat government – under the fourth unelected Italian premier in a row – risks feeding the mood of insurrection. And Italians have learned by now that the EU is the villain in this saga.
Antonio Patuelli, the chairman of the Italian Banking Association, says the EU authorities have themselves created a self-fulfilling crisis by endlessly raising the bar with pedantic stress tests that create generalized panic. „Europe’s bureaucracy has a very strong responsibility for has happened,“ he said.
„In Italy everything can be sorted out, but as soon as we face an EU rule people react as if it were the Tablets of Moses. The stress tests have created an extreme mechanism leading to a chain-reaction of extremes,“ he said.
What sticks in the craw is that the EU has imposed stringent rules that prevent Italy defending itself – and let foreigners snap up distressed assets at firesale prices, Italians note caustically – yet the northern creditor powers have never delivered on their side of the bargain. There is still no joint deposit scheme or shared risk. The banking union remains a sham. „It is difficult to find anybody today who is willing to believe in Europe,“ said Mr Patuelli.
Instead Italy must listen to admonishments from the Dutch Eurogroup chief Jeroen Dijsselbloem, who’s own country bailed out of three of its four largest banks in a massive state rescue after they ran amok.
Italy’s sedate lenders never had a speculative boom. They have been brought low by the chronic effects of economic depression, that is to say by the contractionary policies and self-defeating austerity forced upon the country by the eurozone machinery between 2010 and 2014.
For now the ECB – through the Bank of Italy – is keeping a lid on the smouldering crisis by mopping up Italian debt and suppressing yields. Mirabile dictu, the risk spread on 10-year Italian bonds has dropped to a one-month low of 154 basis points.
This stores up trouble for later. The Bank of Italy will have less of its quota left in February when the treasury must redeem €49bn of Italian debt, and when the politics may be red hot again.
We will find out on Thursday whether the ECB’s governing council considers itself such a captive of the markets. All signs are that it will be fractious meeting as the hawks gather for a counter-attack, irked by incipient property bubbles, and worried that QE will be pushed beyond the point of central bank solvency.
“It is a dangerous notion that central banks can counter the causes of financial and sovereign debt crises, of globalisation fears or of rising populism, with cheap money,” said Bundesbank chief Jens Weidmann earlier this week.
This is not going to end well for Italy. The attrition from the Long Slump has done too much damage to the industrial core and to the fabric of the labour market. You can only pauperize a nation for so long before it explodes.
The great canard is that Italians are not patriotic, that they somehow prefer to be governed by Brussels, Frankfurt, or Berlin.
Patriotism runs through the 14th Century poetry of Petrarch, and through the works of Machiavelli a century and half later, both heart-broken and inflamed by rampaging foreign armies.
Every Italian school-child knows the tortured verses of Giacomo Leopardi’s „All‘ Italia“ and the haunting question he asks: „Who reduced her to this state?“
Sixteen years into the disastrous 21st Century they have a very strong suspicion who reduced her.