Wednesday 17 January 2018

Big Short 2 as markets swing against Italy's banks and bonds

John Geddie

SPECULATORS convinced the eurozone faces fresh instability have zeroed in on Italy's constitutional reform referendum on Sunday, amassing huge bets on a slump in Italian banks and bonds should Prime Minister Matteo Renzi lose the vote.

Blindsided by skewed bookmakers' odds and equivocal opinion polls, financial markets ended up on the wrong side of Britain's vote to leave the European Union in June and Donald Trump's surprise US election win last month.

Perhaps chastened by their miscalculation of public disaffection in those two pivotal 2016 events, bets against Italian assets appear to show markets now assuming voter rebellions in Italy and the rest of Europe.

"There are colossal short positions on Italy from the US and other countries where big investors are based," Raffaele Jerusalmi, the ceo of the Italian stock exchange said this week.

Shorting, or selling a borrowed asset, is a technique traditionally used by hedge funds to bet that the value of an asset will decrease.

Data from the Italian market regulator shows "significant short positions" in Banco Popolare Di Milano and Banca Carige, while the regulator has restricted short-selling in shares of floundering Monte dei Paschi since July.

Weighed down by banking shares, Italy's main index is the worst-performing stock market in the developed world this year, having shed more than 20pc. Steve Eisman, who made his name and fortune by betting against subprime mortgage securities, as portrayed in the film 'The Big Short', outlined to Reuters his extremely negative views on Italian bank equities.

"Nobody is going to invest in the Italian banks unless they trust their balance sheets," said Eisman, adding that Italian lenders have been "very slow" to recapitalise and sell off troubled assets.

"In the Italian system, the banks say (assets) are worth 45-50 cents in the dollar. But the bid price is 20 cents. If they were to mark them down, they would be insolvent."

There is also evidence that investors have taken short positions in Italian government debt on a scale not seen since the eurozone debt crisis of 2011/2012.

A sharp fall in the price of futures contracts, agreements to sell bonds at a specified price at a later date, and a corresponding rise in outstanding contracts called 'open interest' is a tell-tale sign of shorting, say analysts. The jumping cost of hedging against swings in the euro's value next week also suggests investors are bracing for widespread fallout from Sunday's vote. But for many money managers, the outcome is far from clear.

For a start, markets are once again chiming with opinion polls that suggest Italians will reject Renzi's reforms, aimed at bringing political stability to a country that has had 28 governments in 50 years.

Doomsday scenarios assuming a snap election if he resigns following a 'No' vote may also prove wide of the mark.

Berenberg's chief economist Holger Schmieding sketched out three alternative scenarios to "unlikely" elections: President Sergio Mattarella could re-appoint Renzi, mandate another centre-leftist to form a new government, or even try to persuade Silvio Berlusconi's centre-right party to join or support a caretaker or technocratic government.

Meanwhile, the European Central Bank has pledged to stem any market fallout by upping its purchases of Italy's debt. (Reuters)

Irish Independent

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