French President Emmanuel Macron, German Chancellor Angela Merkel and Italian Prime Minister Paolo Gentiloni chat in while in Sicily last month for the G7 summit. Photo: AFP/Filippo Monteforte

The bank sector of the EuroStoxx index was down almost 2% at 9:00 am EST but recovered to show a loss of just 0.25%. More interesting is that Italy’s largest banks, Unicredito and Intesa Sanpaolo, ended the day respectively flat and up 0.5%.

Italy’s sovereign risk meanwhile continues to shrink, with the spread between 10-year Italian and German government debt down to 1.67% from last week’s peak of just above 2%. Germany and Italy have submitted a joint document to the European Commission urging the EC to recognize the “social costs” attendant upon the resolution of bankrupt banks, which is a statement that Germany will help Italy ease the pain of bank resolutions.

As Asia Unhedged reported last week, a deal is shaping up in which Europe will help Italy fund its debt (through the “safe bond” scheme”) and Italy will acquiesce to the elimination of negative interest rates, which are onerous to German savers. With the defeat of Italy’s populist parties in last Sunday’s local elections, the stage is set to draw Italy into the Franco-German deal that emerged after the election of Emmanuel Macron. So far, the frame is holding, and if it does, it should be good for German stocks.