Contagion Has Limits

Contagion usually has limits, especially considering the unavoidbale truth that Italy cannot be allowed to exit the Eurozone. Italian bond suffered their worst day since the peak of the Eurozone crisis as 10-year yields soared nearly 50 basis points leading to a global bout of risk aversion. The yen was the top performer while the euro lagged. Month-to-date, silver is the strongest, followed by the franc & the yen. Euro is the weakest, just ahead of the pound. A new JPY trade has been issued to subscribers, explained in detailed in the member's video below.

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It was a harrowing day in the Italian debt market with 10-year yields rising 48 basis points to 3.16%. It's the continuation of a one-way move that started in the second week of May at 1.80% in response to political turmoil.

A new election is now the likely scenario and may come as soon as July 29. Efforts to form a caretaker government have stumbled in part because some politicians and technocrats may be loath to participate. What's more important at the moment is that the worries have spread. Italy is the fourth-largest debt market in the world and the turmoil created a massive bid in US Treasuries, sending yields down 12-16 bps across the curve. In turn, the yen and Swiss franc soared. Indices fell hard, with the DOW30 dropping over 400 pts. 2 weeks ago our Premium short in the DOW30 Premium was stopped out at 25,050, before the index crawled up 36 pts and later fell 700 pts.

What's next? The contagion has a limit. There is clearly some forced selling in Italian debt at the moment. Once (if it) it ends, debt elsewhere will stabilize and reverse the yen moves. The Swiss franc may maintain a stronger bid due to its proximity to Italy.  Ultimately, the trouble in Italy will be contained – this isn't going to derail the global economy -- but the question remains: when does it stabilize? We will be watching closely for a formal announcement of new elections and how the market reacts.

In the meantime, technicals are cautionary. EUR/JPY is at the lowest in 11-months and global equities took a hard hit. A strong rebound in some assets may be near but the euro may be slow to turn.

In the short-term, domestic economic data is likely to be overshadowed by global sentiment. Japanese retail sales and Australian building approvals are on the calendar in Asia. The Bank of Canada decision is later with the latest turmoil solidifying at least another six weeks of wait-and-see.