Over the past several months, Italian budget risk and EM FX woes have taken turns denting risk sentiment.

The old “If it’s not one thing, it’s another” refrain very often takes the form of “If it’s not turmoil in EM FX, it’s a bloodbath in Italian assets“.

But Italy jitters and EM woes aren’t mutually exclusive. There’s a nexus there. UniCredit, for instance, controls 41% of Yapi Kredi, and that exposure was brought to the public’s attention in August as the Turkish lira collapsed.

(Goldman)

In addition to the direct exposure, what’s happening in some developing economies serves to amplify concerns over Italy as the turmoil in certain EM locales is a stark reminder of how quickly the market can lose confidence in deteriorating economic fundamentals.

Well, as you may be aware, Italy is heavily represented in Euro HY. We’ve been over this on countless occasions previously. In light of the ECB winding down CSPP and considering the recent budget drama in Rome, it’s worth asking whether the potential exists for a kind of “double whammy” scenario where the relative weighting of Italian credits at the index level ends up causing problems at a time when spreads are set to lose the technical tailwind from CSPP.

When you throw in the EM nexus, this gets even more dicey (and even more convoluted).

“We think investors should be cognizant of the demand-sapping effect of EM volatility on European high yield”, BofAML writes, in a note dated October 5, on the way to highlighting the following set of charts.

(BofAML)

That visual in the right pane is pretty astonishing. The correlation of Euro HY fund flows with EM FX is near 90%.

This comes at a delicate time. Rising yields on USD “cash” (i.e., short-term USD fixed income) are sapping demand for speculative grade European credit (and for risk assets more generally). Meanwhile, the ECB is preparing to turn off the liquidity spigot and when the price insensitive Draghi bid dries up at the top of the quality ladder, you’re going to see the dynamics that drove everyone out the risk curve reverse. That means high yield spreads are likely to start reflecting sector- and credit-specific risk again as opposed to being priced to perfection on the back of the global hunt for yield.