As expected the Italian election produced an inconclusive result. None of the political parties obtained an absolute majority and we are likely to face a long period of uncertainty. In 2013 it took two months to form a government.
- The Five Star Movement did not obtain an absolute majority. The probability of this happening was always very remote.
- The Five Star Movement was the most voted party with 32% of the votes. They performed better than expected.
- The Lega party (former Northern League) gained 17% of the votes. Importantly they obtained more support than Forza Italia (Berlusconi’s party).
- The populist parties obtained more than 50% of the votes and are likely to be present in the government.
- The centrist parties lost ground to the populist ones. The Democratic Party result was particularly weak; Renzi is likely to resign.
Within the likely scenarios, today’s result is towards the most negative outcome. From here the greatest risk is that Five Star forms a coalition government with Lega. This is very unlikely but not impossible. The most likely outcome is a long period of uncertainty (constant headlines – probably unhelpful ones) leading to a government with Five Star or Lega the main actors and maybe protagonists.
The European Central Bank and the Bank of Italy are still buying BTPs (Italian bonds) on a daily basis, which is likely to provide some support in the market. In April there is a large amount of maturities that will require reinvestment, so the technical environment is benign for European bonds. Aside from this and given the relatively muted reaction, the ECB will likely be unfazed with this result. Ultimately the result reflects the will of the Italian people.
Fundamentally the situation is likely to deteriorate in Italy. Political risk will remain elevated in the coming months. Economically looser fiscal policy (with an already elevated debt to GDP level) and a more confrontational stance versus Europe are likely to put off some investors (such as Japanese investors). This should result in higher BTP yields and wider spreads versus core and semi-core markets.
In conclusion, the electoral result is not positive for Italian assets. Uncertainty will require a larger credit premium. As active managers this is something we will aim to profit from: this morning we have reduced our Italian risk and in unconstrained portfolios have sold Italy versus Spain on the expectation it will underperform in the near term.