Haven Can Wait

Last week's feel-good market - with its narrative centred on the perpetual beta chase in tech and self-fulfilling bets on oil - is now a distant memory given the renewed attack on the inherently unstable Eurozone by the latest crop of Italian populists. After market participants worrying about it for years, "Quitaly", the Italian cousin of Brexit, is now on the front burner.

This has the crowded long trades in both WTI and the Euro on the back foot. The cock-sure shorts in the 10 U.S. Treasury market are getting squeezed hard in the face of unrelenting demand for haven assets. It seems Yogi was right last week.

As Mario Drahgi seems now to have lost his duplicitous grip on the Italian bond market, the Achilles' heel of Europe, the bank stocks, have started to break down. Eurozone Financial stocks are the canary in this coal mine and the picture they paint isn't pretty, as the chart below shows.

iShares Europe Financial ETF

The Doom Loop

According to Bruegel, a European think tank, the implications for Italy under the current coalition government are dire:

"... none of the powerful stabilisation instruments that the euro area has developed over the years could be deployed to rescue Italy. Following crisis-related downgrades, Italy would no longer be eligible for the ECB’s quantitative easing bond-purchasing program. The ECB would stop accepting Italian bonds as collateral. Access to emergency support programs—the ESM, and through it, the Outright Monetary Transactions (OMT) program—would be conditional on fiscal adjustment, the opposite of what Italy’s new government has promised."

The loss of access to markets for the Italian government would make the 2011 Greek crisis look tame. At nearly $2 Trillion Euro, the outstanding stock of Italian government debt, much of it held by banks, is five times that of Greece. The so-called "doom loop" of sovereign debt downgrades which in turn affect bank ratings is now in play.

When it comes to Italian politics however, the possible permutations are endless. The current proposed government, now obviated by presidential edict, would have seen northern rightists join forces with southern leftists, the only intersection in their incongruous Venn diagram being their populist leanings. New elections have been proposed and that outcome is now more than a summer away. Much can change in that time frame. But ultimately, I don't think the Italians have the stomach for a full blown crisis.

This morning cooler heads seem to be prevailing and we are seeing signs of a bottom fish mentality developing. A strong supportive statement from the European Central bank, backed by Germany would go a long way to calm the nerves. Notwithstanding this bounce, the European markets, especially their basket case banks, will be off limits as the drama in Italy plays out over the next six months.

The playbook has been well rehearsed by many financial macro players. Like vultures, they will start to circle the most wounded assets, picking off the weaker sellers who are in margin call mode. The action today will be critical. Since this is a Tuesday, a reversal day, the close today should be instructive. The copper/gold ratio is holding in nicely and the VIX move looks subdued. Italian bonds have started to bounce already, fuelled by possible ECB support action.

Maybe haven can wait.

Meantime, Canada has used the bazooka on B.C. and taken Kinder Morgan out of the political pipeline business. Because of the rumours of this, I covered my CNQ short on Friday but I'd still be cautious on oils going into the OPEC meetings next month. This fight is long from over.

Risk Model: 4/5 - Risk On

The slight drop in AAII Bull/Bear into risk off territory, unlikely to reverse this week, is the lone dissenter to the bear case. With last week's oil collapse and sharp deceleration in the Canadian market, the RSI corrected its overbought condition. As stated above, copper/gold is behaving nicely, albeit with both metals taking a breather under the withering assault of a surging greenback. This bodes well for economic growth conditions even though the macro headwinds of Eurozone political unrest, possible trade wars and economic sanctions would seem to argue otherwise. Dr. Copper is setting up a nice basing pattern in front of beneficial seasonality. All it would take would be a China and/or NAFTA trade deal and - boom! - off the base metals would go.

Fed Board member Bullard, a noted super-dove, was again warning this week about possible over-tightening by the central bank in the face of stubbornly low inflation. We get data of Friday outlining core PCE prices that should show another tame print. The dollar strength against the EURO, combined with an oil peak should help bolster Bullard's case for only one more rate hike before the FED takes a pause.

In an environment of a very flat yield curve, this can only help the case for an out-of-consensus FED rate hike pause after the upcoming June meeting. The Metals would love that!

Watch this space.