Italy's populist Five Star Movement leader Luigi Di Maio (L), shakes hands with Italian lawyer Giuseppe Conte, a possible choice to lead a coalition government.

Heavy trading in Italian bond and equity markets continued to start the week, as investors brace for what many see as a nightmare scenario in the country’s politics.

Two stridently populist parties, despite being on radically different ends of the political spectrum, are poised to cobble together a coalition government, which could fuse contradictory policy priorities of large tax cuts and universal income.

There are some signs that the left-wing Five Star Movement and the far-right League party will back away from their most radical proposals, as The Financial Times reported Monday:

“Nicola Mai, sovereign credit analyst at Pimco, said the coming weeks would see a stand-off between Italian politicians and the markets, as the nascent coalition government tested investors’ tolerance for its policies.

“The market sell-off had ‘obviously been a factor’ in the populist parties’ retreat from some of the more radical policies set out in a draft coalition agreement leaked last week, which sparked the ongoing bout of market turbulence, he said.”

As Asia Unhedged noted last week, Italy’s size and its massive US$2 trillion in outstanding government debt mean that a run out of Italian assets would send shockwaves around the globe.

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