Italy Following Greece

Greece gave you a rough template for how these political fights between anti-Euro and Euro establishment play out.  The first thing that happens is that these weak economies in the EU breed populist uprisings, which plant anti-Euro populist politicians into their parliaments.  The first thing they want to do, like most politicians, is to spend like drunken sailors hoping to spend their way past their problems.  This can happen when there is monetary and fiscal sovereignty, but under the euro construct, monetary policy is set by the ECB and enforced with fiscal stipulations that limit budget deficits.  This effectively prevents expansive fiscal policies these populists desperately want. 

So what happens is that the populists threaten to break EU laws to increase government spending, but want to stay under the euro currency.  So they want all the benefits of the euro currency without any of the drawbacks.  When Greece did this, eventually they ended up kicking the can down the road, and that is the most likely scenario for Italy.  Italy is in a much stronger position that Greece, so they are not completely comparable, but since February, it is sell first, ask questions later.  Italy doesn't have as much an economic problem as a political problem.  Italy is basically the same crappy economy since 2008.  Unless the populists go all the way and actually leave the euro (it would be a long term benefit for Italy, which badly needs a weaker currency), then they accomplish nothing but higher yields and a worse economy for Italy.  But that is exactly the most likely scenario, as Italy want all the benefits of the EU without having to abide by its arbitrary budget rules.  Eventually they will cave in, just like Greece, and stay in the EU and it will be all for naught.  Only when the EU economy is absolutely going downhill will there be some incentive to leave the EU and try to print their problems away.  Until then, Italy will be Greece Extra Light. 

The only thing new that we've discovered over the long Memorial Day weekend is that Europe's financial market is fragile, and it never went away even with the massive QE and super low rates.  That is why the Eurostoxx isn't able to bubble higher like the SPX all these years, even as the European economy got stronger. 

Don't let the VIX fool you.  There are lots of risk underneath the calm surface.  Tighter Fed policy being the main one, but overvaluation is not far behind in catalyzing big down moves with relatively insignificant news.  Under these panicky headlines, you can clearly see that bond yields are plunging,much more than stock indices are.  That tells you where the pain trade is: rather than lower equities, it is probably lower yields.