Italian Bonds, Stocks Crash In Furious Reversal As Political Drama Explodes

Yesterday, in the aftermath of the latest Italian political drama, in which president Mattarella openly mocked democracy, and vetoed the choice of the euroskeptic economy minister Paolo Savona, we warned that this outcome was even worse for markets than the one which most had dreaded, namely Mattarella folding and greenlighting the 82-year-old professor for reasons we laid out article from Sunday.

Algos still don't understand that appointment of Savona was "best" worst case scenario https://t.co/EbYlkkHpuw

— zerohedge (@zerohedge) May 28, 2018

What happened next was a full court press by so-called experts and momentum reversal algos to spin yesterday's outcome as good news, and sure enough in early trading the EUR bounced sharply, rising above 1.17, Bunds slumped, and Italian bonds and stocks gapped higher at the open.... and then all hell broke loose when, just as we predicted, Mattarella's decision simply reinforced the League's position, when shortly after the open, League leader Matteo Salvini reiterated his support for Savona, and in a Facebook video said that "either EU rules will change or it makes no sense for Italy to remain in the European Union." Worse, dragging Italy to the verge of the constitutional crisis we warned about yesterday, Salvini turned the nation against the Brussels-lackey president and said that Mattarella "chose EU rules over Italians’ vote" which he said "is an issue for democracy."

And the punchline: he said that the League will seek to form a government with people rejected by Sergio Mattarella.

Effectively, Salvini confirmed what we said yesterday, that the stakes in the upcoming Italian elections were just raised exponentially, which has now become a referendum on euro membership.

Meanwhile, shortly after noon local time, in purely symbolic gesture, the Italian president gave the mandate to form a government to ex-IMF official Carlo Cottarelli, 63, whose task to form a technocratic government has zero chance of success. Cottarelli said that if he is successful in forming a government - which he won't be - the next Italian elections would take place early 2019. If he isn't, and he won't be as all the top parties have already rejected his attempt, the next elections will be in August or shortly thereafter.

“The President has asked me to go before parliament with a program that will bring the country to new elections,” Cottarelli said after meeting President Sergio Mattarella.

By this point the market, however, couldn't care less what this meaningless figurehead had to say, as both Italian bonds and stocks were plunging, having realized what we said on Sunday, that the worst case scenario was unfolding, especially since as Goldman noted last night, if the elections were held today, the 5-Star and the Lega would win over 55% of the vote, a 10% improvement to their showing in the March elections.

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The result was a painful and furious reversal for the Italian bulls who naively bought into the "bullish" narrative as Italian yields staged a dramatic reversal, with 2y yields surging after being down as much as 20bps, then exploding as high as 0.972%, while the curve continues to aggressively flatten with 5y higher, in no small part due to lack of liquidity as suddenly the ECB is all too absent from the bid-side.

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This took the yield on 2Y paper to the highest level since 2014, rapidly approaching Draghi's "whatever it takes threshold."

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Meanwhile, 10Y Yield also soared, rising as high as 2.70% and now rapidly approaching the nominal level of 10Y US treasurys...

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... while the Italian-German spread has exploded to 230bps, the highest since January 2014, and is now well beyond the 200bps level which Goldman predicted last week would lead to Portuguese contagion.

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Meanwhile, Italian stocks were similarly hammered, and after spiking higher at the open have since tumbling

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Finally, and most ominously, after an initial attempt to "celebrate" the Italian news, the EURUSD has since reversed all gains and in an indication that traders are now openly worried about Italian contagion, has tumbled to the lowest level since November 2017.

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But the clearest sign that the European crisis is back, came not from Italy but from Spain, which is also suffering its own political drama with the imminent vote of no confidence in prime minister Rajoy, a process which was started this morning and is now scheduled for Friday assuring a week of non-stop European drama. But what really sealed it was a comment from BBVA’s analysts Pablo Zaragoza and Jaime Costero who in a note this morning said that "Spain is not Italy."

The last time we heard this, Europea was about to implode and only drastic action from the ECB saved it. This time, Draghi's bazooka is all but spent, unless of course the world's biggest hedge fund starts openly buying ETFs and single name stocks, which it eventually will...