Tracking EUR/USD Recovery: Italy in play? Two potential targets; then short?

24 February 11:39 a.m. ET

The chart on the next page shows the EUR/USD (black bars) versus the 10-year benchmark spread between Italy and the Eurozone.  As this spread widens it is indicative of more risk from the Eurozone.  Rising debt and bad loans on Italian bank balance sheets is now again playing into yield.  According to George Friedman, of Geopolitical Futures, who has been watching this Italian banking dynamic had these comments in a recent piece whereby he commented on Brexit:

There is another dimension to this deal. Our readers know the we have been predicting a financial crisis built around the Italian banking system. This weekend, Reuters indicated there is a “new storm on financial markets” emerging in the eurozone. One of the key contributors to this storm, it was argued, is Italy.

The central argument of the Reuters article was this:

Global market turmoil since the start of the year has helped set warning lights flashing in euro zone sovereign bond markets. In early February, the premium that investors charge to hold Portuguese, Spanish and Italian government debt rather than German bonds hit some of the highest levels since the euro zone crisis that peaked in 2011-2012.

European bank shares have been badly hit by concerns over their high stock of non-performing loans, new regulatory burdens and a squeeze on profits due to sub-zero official interest rates. New EU banking regulations that force shareholders and bondholders to take first losses if a bank needs rescuing are further spooking the market, notably in Italy.

Geopolitical Futures is not, for better or worse, the conventional wisdom, which is often represented by the media. However, it is significant that the severity of Italy’s financial problems has been picked up by the mainstream press because what the conventional wisdom says matters. It matters for three reasons. First, conventional wisdom can become a self-fulfilling prophecy. Second, what used to be an obscure idea can be elevated to mainstream thinking. Third, it makes me feel good to have Reuters pick up a theme we have been addressing since our founding.

In terms of financial crisis, the first point is important. As I have argued, markets are not about reality but about perceptions of reality. When Reuters says that a new market storm may be coming, they have changed the definition of reality. What has been a preposterous marginal view becomes the mainstream view. And people act on the mainstream view, particularly funds investing other people’s money, whose primary goal is to not look abysmally stupid. Doing what everyone else does may be stupid but not abysmally. Therefore, a spate of articles by Reuters could trigger what we have thought is coming.

As you can see in the chart below, the euro has actually been “benefitting” from the rising yield spread between Italy and the Eurozone.  It has been the “safe haven” if you will as locals repatriate and banks delever.  The 21-day correlation between the spread and currency pair is a whopping 80%.  The key question:  How long can this last?

Technically, I have shown two recovery targets: 38.2% at 1.1119; and 61.8% at 1.1217…looking for a potential short setup here…