GLOBAL CREDIT BULLETS | Monday, 18th July 2022

Italy – Political drama is back.
In Italy, a new government crisis opened up as the 5-star movement de facto removed support to the government. In principle, the government has a majority even without 5S support. In practice, however, PM Draghi has reiterated multiple times that he would not continue his task without broad-based support. As a result, he delivered his resignation to President Mattarella. The President, in turn, rejected PM Draghi resignation and asked him to go in front of the houses to get a confidence vote. The vote is scheduled for Wednesday. For the current government not to fall, it is then required for the 5-star U-turn and back PM Draghi, or for Draghi to accept to govern with a less uniform majority. While both are possibilities, the tone over the past few days suggest both options are still far from being confirmed. In case Draghi decides to confirm his resignation, President Mattarella can still decide to try and form a government without going to early elections. The new government may have Draghi as PM with a different majority, or another non-political figure. Early elections are likely the less preferred option for the President (they would take place in early October if called). Overall, we see little interest for any party to go to early elections, perhaps except Fratelli d’Italia which is not part of the majority. So the week is going to be bumpy but the crisis will most likely resolve without the most volatile outcome. However, the bout of political volatility is a reminder of markets of the upcoming political risk, which will need to result in elections by April 2023 anyways. On Thursday, BTPs turned volatile again, and the spread vs bund reached 225bp, the high since early June. The ECB work on the anti-spread tool is arguably complicated by politics, as domestic developments do not constitute genuine fragmentation. Volatility on Italian assets is thus likely to remain elevated over the next few months, and the market is likely to try and test new highs on BTP spreads.

ECB – A tricky meeting.
We think the upcoming July 21^st meeting will prove tricky for the ECB. The central bank has recently committed to hike 25bp, guiding for larger hikes later in Fall. However, the Fed is likely to hike 75bp just five days later, and the EUR/USD is flirting with parity, making riskier for the ECB to stand to its word. We think the hike will ultimately be in line with guidance, as it’s too late to create a new consensus around a larger move. The meeting may thus create market volatility and will need to be coupled with relatively strong guidance about future increases. Post Fed, the gap between US and EU policy rate will be 250bp, clos to historical highs. The meeting will carry no update of economic projections, but the ECB may point to more pro-inflationary risks following the upside surprise in June inflation. The ECB is likely not to provide any more details about the anti-spread tool, especially in light of the political situation in Italy. The market is pricing some 35bp into the meeting, thus attaching decent chances to a 50bp surprise hike. The terminal rate is still priced around 2%, in line with plausible ECB paths. We thus think the meeting will bring in little surprise on the expected rate path, but may trigger more volatility on BTPs and the Euro depending on the communication.

European energy – Mind the gas.
On July 21^st, Nord Stream 1 is supposed to come back online after the maintenance period started last Monday. Markets are concerned about gas flows not resuming at pre-maintenance levels, and have thus stayed weak over the past ten days. Over these days, we gain little signals about Russia intentions to send gas back online. Mechanical pieces from Canada have been delivered, but Gazprom communication have remained very vague about the viability of flows resumption. Any signal from Russia or Germany on Thursday or Friday will thus be very closely followed. Gas flows from Russia to Germany have fallen to 60% of pre-war levels in June, a level that would just allow for no rationing in winter. Germany will thus remain on the edge and a further reduction may trigger more emergency policies from the government. Markets, however, are pricing a decent chance of this event and any positive signal may trigger short-term relief.

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Algebris Investments’ Global Credit Team