Yesterday after Berlusconi announced plans to resign, I tweeted (@fundmyfund if you wish to follow) that tomorrow we'll wake up and Italy will still remain a low growth, prone to recession, high debt country - nothing really has changed.  Obviously 'the market' could have cared less yesterday as it went all giddy, but this morning it has changed course 180 degrees.  Sort of like a wild party Saturday night, and today is the hangover.

Italian yields jumped over 7%, and quickly are reaching the danger point.

  • Investors dumped Italian government bonds, sending the yields well over the 7% level that forced Greece, Portugal and Ireland to seek international aid. The spike came after clearing firm LCH.Clearnet raised the margin, or collateral, that traders must deposit to trade Italian bonds across all maturities.

I've said for a few quarters now the end game is the ECB throwing away all historical precedent (and their charter) just as the Federal Reserve was forced to do, and start their own version of quantitative easing by buying bonds in the market.  If not, vigilantes will just go from one country to another and eventually get to Spain and France.  Obviously in the U.S. that decision could be made essentially overnight, since the Fed already had the tools and authority to basically do whatever it wants.  Not so much in Europe.  Further, it will be a sea change in attitude because of the conservative German outlook on money.  But I don't see any other way out of this mess other than eurobonds.... and obviously storing junky bonds on the central bank's balance sheet is a far easier solution.

  • Germany's wise men panel of economic advisers warned the European Central Bank it risks losing credibility by buying the bonds of heavily-indebted euro zone states, and that monetary and fiscal policy are becoming worryingly blurred.  
  • The group, which advises the German government, said in a report published on Wednesday: The bond buying program dismantles market discipline without establishing any political discipline in its place.  In blurring monetary and fiscal policy, the report said, the ECB is jeopardizing its credibility, because it is falling under the suspicion of monetizing sovereign indebtedness.

So we wait for the end game .... as I have repeated many times, the irony in all this is if every country had their own currency we would not have any serious 'issues' other than a bunch of countries who spend like drunken sailors and then debase their currency to pay for it.  While it leads to lower standards of living, and just shovels debt from one hand (govt) to another (central bank), it's been working like a charm for the U.S. and Japan.... and even U.K. nowadays.

As for the market, it remains near impossible to trade when you rally 100s of points on first a rumor, and then a face of a politician's fate, and then the very next morning lose all those points in an instant.

I will again highlight to readers the ultimate scary one is France.  They have been seen as the twin brother of Germany, but their fiscal house is much more of a mess and they have been given a free pass during this whole crisis.  If Europe somehow thinks the ESFS bazooka can save Italy and Spain, they will finally relent when the vigilantes turn to France.