I generally try to avoid joining the media frenzy around a particular market topic because the media tends to distract me from the “real” story in many cases. Today I am making an exception. The sovereign yields of Spain and Italy are no distraction. They are a crucial part of the market’s story, and of the economic and political future ahead of us. Here’s the chart of 10 year Spanish yields over the past 5 years:
With the 10 year yield testing its November high of 6.69, it is no surprise that cries of “ECB intervention!” are getting louder by the day. The issue here is that the ECB’s previous interventions have exposed it to more and more peripheral risk in each round. In the most recent LTROs, Spanish banks have been the most aggressive in offloading balance sheet risk to the ECB, as FTAlphaville’s article here makes clear. For those interested, you can also read our previous post about the funding risks in the Greek banking system.
In short, the ECB is becoming more and more concerned about its own balance sheet risks. That concern was likely the main catalyst for the recent comments from ECB officials that they would not be adopting any new interventions until July, while they complete an internal assessment.
Putting the tea-leave reading aside though, what does all of this mean for traders like us? Most importantly to me, this confluence of events (sovereign yields spiking, European bank stocks and the Euro making new lows, and the ECB on hold at least until after the Greek elections on June 17th) is the main reason why I have been comfortable holding on to my long June options. It is rare that you see so many potential flash points jammed together in a one month period. If that was not enough, we have the FOMC meeting on June 20th.
I have a hard time seeing the VIX get much below 20 with this backdrop. While Greece is only the 35th largest economy in the world, Spain and Italy combined would be the 4th largest economy in the world. As a result, though intervention seems unlikely for now, if and when it comes, it has the chance to cause some very big moves to the upside as well. With the hope that we can take advantage of both directions, here’s to a fruitful summer trading options.