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Decimal Digest
21 May 2012

Italy’s TARGET2 liabilities

For last few months, the bond market is seemingly treating Italy with more respect than it used to do in 2011. We hear a lot regarding the market belief that the new government in Italy will be able to manage the economy better.

As everything else in Eurozone, one needs to crosscheck before one believes in any development. The author of this note has been fortunate to observe closely many market interventions by authorities – interventions solely for the purpose of showing a particular asset price level. All the price interventions can be decoded when one looks at the flow data in conjunction with the price movement. If the flow data matches the direction of price movement, one can believe that the price movement is based on genuine demand and supply. If the flow data diverges from the price movement, one can guess that either the demand or the supply is being managed.

With this preamble, lets look at TARGET2 balances of Bank of Italy, as shown in the chart below:

Chart 1: TARGET2 balances of Bank of Italy, Billions of Euros

Source: Decimal Point Analytics

Longtime readers of this weekly will know that accumulation of negative TARGET2 balances indicate building up of stress in the domestic banking system. It is interesting to note that, till July 2011 Italy was running positive TARGET2 balances, and in last six months the situation has suddenly deteriorated. This does not tally with the improvement in printed yields on Italian bonds. We leave it to the imagination of readers to speculate on covert intervention in the Italian bond market by the authorities.


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