June 12, 2018 / 3:10 PM / a year ago

Breakingviews - Cox: The big Italy short was hiding in plain sight

AMSTERDAM (Reuters Breakingviews) - The marriage of politics and finance in Italy regularly produces strange offspring. But a suggestion, floated over the weekend in the country’s most-respected newspaper, of a James Bond-style plot by some big investors to sink Italian financial markets added a new twist. More curious was the theory’s abrupt disappearance by Monday. The episode highlights the degree to which Europe’s most chaos-resilient economy has entered a risky new paradigm with the arrival of the most populist government since the Italian Republic’s founding in 1946.

Actor Daniel Craig poses for photographers on the red carpet at the German premiere of the new James Bond 007 film "Spectre" in Berlin, Germany, October 28, 2015. REUTERS/Fabrizio Bensch

On Saturday, Corriere della Sera, the Milanese voice of the establishment, published an article which speculated that some investors betting against Italian assets might have helped engineer a market crisis. The trigger for the Italian panic was the May 15 publication by Huffington Post’s Italian website of a draft version of the new government’s “contract”, which included language pertaining to a possible exit from the single European currency. That document, HuffPo has said, arrived in an unmarked envelope.

Markets went haywire over the prospect that the government cobbled together by the two parties who gained the most seats in the March election – the right-wing League and hard-to-label 5-Star Movement – would adopt an explicitly anti-euro platform. The difference between the yields on 10-year German and Italian government bonds surged to almost 320 basis points from just around 130 basis points before the draft appeared. Any bets against Italian sovereign credit would have produced a tidy profit.

Corriere has substantially revised the story. It no longer includes language that one hedge fund, Brevan Howard, considered defamatory. That firm’s AH Master Fund, run by Alan Howard, gained 37 percent in May, thanks in part to bets on the direction of Italian assets. On Tuesday, the newspaper appended an author’s note to the piece in which it said: “We never intended to accuse or suggest that there were any kind of offenses or improper conduct by Howard in trading or in his involvement in the case of documents filtered to the Huffington Post.” In a statement to Reuters Breakingviews, the author, Federico Fubini, defended the piece. “We have run a fact-based article whose substance remains.” The paper decided “to amend the text to avert a potentially time-consuming case in foreign courts.”

Truth is, no cloak-and-dagger style operation was needed to form a view that the new government in Rome dislikes the single currency. Italy’s big short was hiding in plain sight. The country’s new leaders, particularly League boss Matteo Salvini, have never made a secret of their distaste for the euro – or nostalgia for the lira. Consequently, for as long as his party remains in government, Italy will pay more for capital.

Indeed, Howard wasn’t the only big investor bearish on Italy ahead of the recent elections. Marshall Wace, Lansdowne Partners, Oceanwood Capital, Caius Capital, AQR Capital Management, Oxford Asset Management and GSA Capital all increased their short positions on Italian assets, Reuters reported in February. Ray Dalio’s Bridgewater Associates had tripled its bets against Italian firms to $3 billion, Bloomberg reported at the time.

And no wonder. The 5-Star Movement in January dropped its call for a referendum on the euro if it won the election. 5-Star leader Luigi Di Maio called it a “last resort which I hope to avoid”. But the League, with whom 5-Star competed in the parliamentary ballot before forming a ruling coalition, hasn’t hidden its disdain for the single currency.

Consider Claudio Borghi, a League legislator in parliament’s lower house who was involved in the drafting of the government contract, and who will help lead the budget committee in the house. The backdrop to the affable former Deutsche Bank trader’s Twitter page is a mock 10,000 lire note. Borghi’s likeness graces the banknote, instead of Alessandro Volta, the electricity innovator who livened up the bills before they disappeared in 2002.

Borghi is one of many League legislators and supporters taking exception to Corriere’s coverage, including the hedge fund piece on Saturday. In a tweet appended to that article, he argued the draft contract never endorsed getting out of the euro or an Italian default – the two concerns that hammered the country’s financial assets. Technically, the draft proposed the creation of an exit mechanism for countries that had adopted the euro, rather than explicitly calling for a so-called “Quitaly”.

Sometimes politicians hold opinions that diverge from those of their parties. Last month, Borghi told the Il Foglio newspaper that while his personal view may be that the euro should be abandoned, “politics is made up of negotiations: and when we are sitting at the table with our allies in the center right, we are aware” that they are not on the same page.

Over the weekend, Italy’s new Economy Minister Giovanni Tria released his first interview since Giuseppe Conte was ratified by parliament as prime minister. The economics professor said all the right things to calm investors: the government is unanimous in not wanting to leave the euro, and dedicated to cutting its debt. The spread against German bonds narrowed. Tria’s interview appeared, naturally, in the paper of record – the Corriere.

Tutto bene? Not quite. The differential is still way above this year’s low of 114 basis points reached in April. Moreover, the League has seen its popularity surge, mainly thanks to its anti-immigration stance. If elections were held today, the party could gain as much as 25 percent of the vote, according to an average of last week’s opinion polls calculated by Termometro Politico, potentially surpassing its coalition partner, which garnered around 32 percent in the March ballot.

With support like that, the League might have little need for coalition partners, or indeed moderates like Tria. That prospect alone should justify a new, and higher, cost of capital for Italy, its companies and its people.

(The fourth paragraph of this item has been updated with comment from Corriere della Sera, to clarify that Corriere della Sera revised the story once and subsequently issued an author’s note, and to change “apologised” to “said” in the middle of the paragraph.)  


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