The slump in Italian sovereign debt on Tuesday underscored that even one of the largest European debt markets is subject to the traders' dictum that liquidity often stops just when it is most needed.
The country struggles to form a government More than two months after the recent parliamentary elections and fears that populist parties could turn a new election into a de facto referendum on euro membership, yields in Italy rose 1, 6 trillion euro (1.85 trillion dollar) bond market.
With liquidity and the lack of willing market makers, the yield premium on 10-year debt has risen to 290 basis points against similar German securities, a value that has not been seen since July 201
"This is not a more deeply liquid market," said Peter Tchir, the New York CEO of MacroS Trategy at Academy Securities Inc. "Everyone was overweight, positioning long Italian debt and the price decline led to one Price erosion on the hot potatoes volatility was so crazy that people's risk managers probably just told them they needed to cut those positions. "
Investors' fear of escalating was the fact that the European Central Bank, the capital and price insensitive buyer of the region, could be
Blackrock's Scott Thiel, who had short BTPs ahead of the Italian vote on March 4, cited poor trading volumes on Tuesday behind "extraordinary" moves in the US
The political turmoil in Italy is so strong that they rekindle the memories of Eurozone worries over the last decade. Billionaire George Soros, who warned of a looming financial crisis and an existential threat to the European Union, is dumping stocks from Stockholm to London.
Dissolving so-called carry trades, which benefit from interest rate differentials and tend to be the best in quieter markets, can also add pressure. Rising volatility in Italian bond yields prompted investors who were long sovereign debt of the country to dump their holdings, according to a hedge fund manager who did not want to be identified because he was not allowed to speak publicly.
The recent disruptions related to Italy stem from the turbulence that has hit emerging market currencies, including the Turkish lira. There was also an episode of increased volatility in the US stock markets in February, which saw a rise in indices such as the CBOE Volatility Index or VIX, a well-respected Wall Street DTM.
For a QuickTake on "risk-on" (19659002) "The Italian bond market reflects a shift in the risk of re-denominating," said Chris Chapman, portfolio manager for Manulife Asset Management. "The movements were probably made worse by the low liquidity, Italy has a large market, but I think there is less liquidity on the road altogether, especially in times of market stress." Electronic commerce becomes less fluid. "
Liquidity Event  There is a chance that Tuesday's sell-off, despite mounting political turmoil, was more likely to be a liquidity event in which buyers simply disappeared than a fundamental revaluation of the Italian debt value outlook
"The worst fears that Italy is leaving the euro or Spain has a non-market-friendly government, there are very few opportunities to materialize, "said Zev Marynberg, chief investment officer of macro hedge fund Adar Capital Partners, which manages $ 1.3 billion in assets. It was an overreaction to recent news in Italy and Spain, and essentially nothing has changed, he said by e-mail.
Spain's growth prospects seem to be more favorable than Italy's – and its bonds have held up better than those of the government in Rome – the country faces political turmoil following a no-confidence motion against Prime Minister Mariano Rajoy .
For Italy, there is a risk that the contagion spreads like in other crises and injures the banks that are there (19659002) "If Italy goes into a deeper and longer-lasting crisis, it could disrupt the distressed assets of Banks seriously affected as the buyers would probably withdraw from this market, "said Nicolas Roth director of alternative investments of the Geneva investment firm Reyl & Cie by email
Of course, the turbulences emanating from Italy are not bad news for all. The macro-credit hedge fund, overseen by Alberto Gallo of Algebris Investments, is benefiting from his bearish Italian bond bets while Bridgewater Associates and Marshall Wace are killing their stakes on financial assets in Italy  US Treasuries Market reaps speculators who for the first time took long positions in futures on biennial bonds last week also an unexpected gain. The escalating crisis in Italy has spurred the search for harbors, dragging bond yields down about 16 basis points to 2.32 percent on Tuesday.
"Unlike US Treasuries, there seemed to be nowhere to hide on Tuesday." Tchir said.
– With support from John Ainger and Suzy Waite