Phew ! Was it all just a bad dream ? Italy bounces ..... and the EU shatters any remaining illusions about its attitude to Brexit.

ref :- "Italy Bonds Rise for Second Day as President Waits on Populists" , Bloomberg Markets

The answer to the question is : "No, it wasn't a dream .... or if it was, it's likely to be a recurring one." Today sees a second day of recovery after Tuesday's panic over Italy's political crisis. Italian Government Bond (BTP) yields are once again sharply lower, with the 2-year BTP yield having traded as low 0.82 % after that barely believable spike took it as high as 2.90% on Tuesday. The Euro versus US Dollar has touched $1.1720 today  --  Tuesday's low was a full 2 cents lower. Just a reaction to an overreaction, or is there some genuinely better news ?

Well, a bit of both ..... Tuesday's crazy moves were definitely overdone (isn't the confidence given by hindsight a wonderful thing ?) and provided profit-making opportunities in a range of assets. On the news front, rather than ranting about a new election (that might become a de facto vote on Eurozone membership), the anti-establishment Five Star and the far-right League parties are trying to agree a new cabinet that will get President Matarella's approval. Given that it was Mr Matarella's veto of the eurosceptic Paulo Savona's appointment as Finance Minister that lit the touchpaper for this chaos, Five Star's leader Luigi di Maio will have to convince the League's Matteo Salvini that they will have to propose Mr Savona for another post .... Foreign Minister is being suggested.

Frankly, we can see a eurosceptic with the Foreign Affairs brief causing almost as many problems as one in the Finance Ministry, but it may be enough for the President to rubber-stamp the coalition government.

More "good news" is that both leaders have firmly denied any desire to quit the Euro. That may be so .... although there must be some doubt about the level of Mr Salvini's commitment to the common currency. One could point out that since the coalition's fiscal agenda is likely to break the Eurozone's rules in a very blatant fashion, at some point they're going to have to compromise either their stated policies or their newly-restored faith in the Euro. But that's for another time ..... for now, calm is restored.

ON THE OTHER HAND ......

It's not done yet ..... not as we write, at any rate. Lingering doubts are probably the reason for that 2-year yield bouncing to 1.36%  --  still, a huge move lower on the day but 54 basis points off its lows. It's a similar thing with EUR / USD, slipping back again to $1.1660. The danger has definitely not passed, and even if a deal is agreed (which is likely to extend the recovery), there's an awful lot that can go wrong going forward ..... those fiscal plans, for a start. Forget the wilder panic-mongers talking of an Italy default .....that's highly unlikely. But policies deemed irresponsible by the ratings agencies may soon prompt downgrades on Italian debt, which would ramp up the cost of borrowing and hurt both the economy, bondholders and households alike.

Note : Spain's political crisis brought on by accusations of corruption against PM Rajoy's PP party is of course also much in the news, making it a particularly hairy time for the mandarins in Brussels and beyond. It's true that tomorrow's no-confidence vote could go a number of ways, but if he gets the support of the far-left Podemos party, the two Catalan parties and the Basque party, Socialist leader Pedro Sanchez could take over. Or a new election could be called ..... the party polling best at present (29%) is Cuidadanos, a party that termed itself centre-left when founded but more recently has described itself as "of the centre", and is actually viewed by many observers as centre-right. The old survivor Mr Rajoy is unpopular but the markets have appreciated the way his discipline has overseen Spain's impressive recovery from a very dark place. They are unlikely to welcome any successor keen to loosen the purse-strings, not one form the left anyways. But whatever the case, this is a very different sort of "crisis" to what's going on in Italy ..... and definitely not an existential matter for the euro that Italy could, just could, turn out to be.

So what's all this got to do with Brexit ? Ever since the referendum, many observers have felt that the EU is bound to take a particularly tough and uncompromising stance on all matters relating to the UK's exit PRECISELY to discourage anyone else from contemplating an exit from the EU or indeed the Eurozone. Despite denials , few really still doubt that has been the case but if they weren't sure of it Michel Barnier put the matter beyond doubt in a speech in Portugal last weekend. He referred no less than five times to Britain having to face the "consequences" of its decision.

It was a message to the UK of course, but at a time when populists in a position of power in Italy are openly talking of their dislike of Eurozone rules and disciplines, it was plainly a warning to that nation too. Which is not good news for the UK and hopes of an amicable, "soft" Brexit, and not exactly a boost for UK assets either.