Italian elections: Overblown concerns or more trouble to come for markets?
Italy has once again found itself in the spotlight for the wrong reasons recently, with the yield on its debt spiking as concerns about its direction under a new populist coalition sending investors fleeing.
In what was a volatile week for Italian debt last week, yields on 10-year Italian government bonds jumped above 3% for a period, before coming back down to 2.7% as investors’ concerns about the measures the populist government will actually introduce eased.
Does the resolution of months of political wrangling mean the volatility is now over? Not by a long shot say experts, who predict this saga has much further to run as the anti-establishment parties may now push forward with plans to exit the euro.
Below, experts from Kames Capital, Insight Investment and Barclays all give their views about what happens next for Italy and the eurozone.
Hao Ran Wee, Investment Strategist at Barclays
“Unsurprisingly, markets fear the prospect of Italy’s government blowing a hole in its budget, prompting a surge in Italian bond yields and provoking a dangerous confrontation with the EU.
“Italy’s populists seem intent on sending a signal to the EU that they will not be thwarted in determining their own economic policies, however fanciful. If the EU objects too much, Italy’s populist leaders will attempt to spook the EU and markets with veiled threats to attempt to exit the eurozone.
“That being said, it’s questionable how credible Italy’s threat of leaving the EU actually is, if push comes to shove. According to its constitution, a referendum on Italy’s membership in the EU/eurozone requires a two-thirds supermajority vote in both the upper and lower houses of parliament. This appears unlikely for now, given that the political majority has shown little appetite for such a move.
“All in all, while the ongoing political situation in Italy is no doubt discomforting for investors, and the risk of an Italian disruption on the European bond market has certainly risen, there remain significant hurdles to the populists’ proposed spending plans, or an exit of the eurozone.
“As a result, we think a repeat of a 2012-style Euro Crisis remains a small possibility, at least for the time being. We remain positive on growth prospects for the eurozone economy, choosing to express this view through a preference for European ex-UK equities.”
April LaRusse, head of fixed income investment specialists, Insight Investment, said:
“In contrast to the European sovereign crisis, Italy is now an idiosyncratic story. Across Europe, previous crisis-hit countries such as Spain, Greece and Portugal are all on an improving path, reaping the rewards of structural reforms implemented in the wake of the eurozone debt debacle.
“In Italy, pension reforms were certainly a positive step, but the country failed to undertake the deeper changes needed to sustainably raise potential growth. The two key parties are proposing a range of expansionary fiscal measures, cutting both income and corporate taxes and proposing a minimum citizens’ income of €780 per month.
“Although more controversial measures, such as asking the European Central Bank (ECB) to write off up to €250bn of Italian debt, have been dropped, investors will be well aware that these were considered serious policy proposals by elements of the new government.
“Debt to GDP will start to rise once again and credit rating agencies are likely to start to downgrade Italian debt, in contrast to the rest of Europe where credit ratings are improving. This leaves us cautious on Italian spreads, especially in an environment where we believe the ECB will be winding down its quantitative easing purchases.”
Stephen Jones, CIO, Kames Capital
‘Following Macron’s victory, the eurozone was the ‘good news’ story of 2017 as the area’s economy burst into life and global investors returned in droves. This year has seen economic momentum collapse sharply and, perhaps more than coincidentally, populist pressures have brought the fault lines back to the fore. For the moment this is an Italian issue, but these pressures exist in most eurozone nations.
‘Equity markets have weakened on these changes, but Italian worries have largely reinforced a trend already in place. Elevated ratings and analysts offering a very rosy earnings outlook left markets vulnerable to poor news and a variety of geopolitical developments have emerged to offer that challenge; fat profits were there to be taken.
‘These risk markets setbacks have, however, taken the steam out of rising short rate and long yield forecasts and will probably succeed in ensuring that quantitative easing is continued in Europe for longer than might otherwise have been the case. When the dust settles, this should underpin equity markets allowing progress to be made afresh and from safer levels; the positive earnings outlook offered by analysts has good real-world support.
‘This supposes that Italy stops short of turning a drama into a crisis of course. Those of us of a certain vintage know well enough that Italian politics are not to be trusted.”