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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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Italy and its politics ..... fascinating of course, and for investors more than a little scary.

May 21, 2018

 

ref :- "Italy waits to find out who its new Prime Minister will be" , Bloomberg Markets

 

Luigi Di Maio and Matteo Silvini, leaders of the anti-establishment Five Star and the far-right League parties respectively, are off to see Italian President Sergio Matarella today. They need to run the agreed political and economic agenda of their populist coalition past Mr Matarella, and to propose their candidate for the role of Prime Minister. We can assume that in an ideal world both party leaders would want the job for themselves, but having won a considerably smaller share of the vote in March's general election (17% to 31%, though the right-wing block's total share is slightly the larger)), Mr Salvini has had to accept that he couldn't realistically put himself forward for the position. What he could do however was make sure that Mr Di Maio couldn't take the job either.

 

It's doubtful whether such a start in life is likely to engender any confidence for the longevity of a coalition between two parties when much of their raison d'etre is to break with the old way of doing things. But then again longevity and Italian governments have never really gone hand-in-hand whoever was in charge. So it's just as well that the Presidency has more powers than is often the case elsewhere, though you'd have to doubt whether Mr Matarella will be totally happy in rubber-stamping all of the coalition's plans. Of course if he refused to do so , that would force a new election but the polls suggest that support for the two populist parties has actually grown since March. A presidential block, unlikely anyway, would probably result in an outcome even more unpalatable to the liberal centre, the EU and, as it happens, to investors.

 

In all likelihood you will know the outcome of the conflab between Mssrs Di Maio, Silvini and Matarella before you read this. The word is that Giuseppe Conti will be the man nominated for PM, and we can't see any particular reason why Mr Matarella would veto the law professor from Florence, who is making all the right noises even if you have to wonder a bit about anyone who would want this particular job under these particular circumstances.

 

We bang on about possible complacency in the performance of markets quite a lot, seen at its starkest last year when some pretty alarming geopolitical developments were repeatedly shrugged off and volatility dropped to super-low levels. It seemed entirely counter-intuitive at the time, and if volatility has picked up since then a chart of Italian assets suggests that complacency must still have been in evidence in 2018. Yields on Italian Government bonds (BTPs) did run up during and over the March election but soon started falling even though the election result could only mean a populist coalition or a return to the polls. The Milan stock market (FTSE MIB) made a high as recently as May 7th. It's as though it's come as a sudden surprise that the two parties in power have come up with an agenda that is decidedly market-unfriendly, when of course it was never really on the cards that it could be anything else.

 

Well, they've woken up now .... the FTSE MIB has fallen from 24360 to 22952 in 10 trading days ; and Italian 10yr BTPs, which were yielding 1.73% on May 3rd, are now trading at 2.27%. Of course , bond yields have gone up across the globe so a better measure of Italian risk is how the Germany / Italy 10yr yield spread has widened .... or in other words, how much more return investors are asking for to invest in Italian bonds rather than their rock-solid German equivalents. In early May the spread was trading at 1.26% and this morning it's knocking around 1.70%. For a spread between the bonds of the first and third largest Eurozone economies, that's a BIG move.

 

The reality of what the coalition's agenda might look like has taken a long time to sink in, and if the moves are big now they might have been even worse. Some of the wildest proposals have been dropped : the plan to exclude €250bn of Italian bond issues from measures of Italian debt on the basis that they were bought directly by the European Central Bank, for example. The League also wanted an exit process from the Euro written into the constitution, just in case anyone in Brussels or elsewhere was still in any doubt about how big a deal this is, and the coalition has talked about a review of all EU treaties and of the European "bail-in" rules for the banking industry, a crucial part of Eurozone strategy to prevent taxpayer bailouts of private institutions,

 

For EU and Eurozone officials, and for the markets, the reality as it stands is frightening enough. Eurozone "rules" state that no participating nation should have a debt level of more than 60% of GDP, that the budget deficit should not exceed 3% of GDP, and have more recently the Commission has made clear that all efforts must be made to clean up the banking industry. French Finance Minister Bruno Le Maire gently reminded Rome of this at the weekend, and promptly received a resounding raspberry in return from Mr Salvini.

 

The coalition's attitude to banking reform squarely contradicts that held in Brussels and Frankfurt. Similarly, their policies fly in the face of those that the European authorities would wish to see adopted. Instead, we should expect a repeal of pension reform and a lowering of the retirement age, a minimum citizens' income for the poor and jobless, and flat tax rates of 15% or 20%, to name but a few. Viewed from the fiscally responsible chambers of Europe (they would claim), these policies are pretty much the exact opposite of the kind of rectitude that Italy needs to get back on track. To believe otherwise you'd have to believe that such expansionist policies will quickly stimulate the spectacular GDP growth required to pay for them, and frankly not many outside of Rome will buy into that theory.

 

The EU authorities Italy's levels of debt are already 132% of GDP and now look set to rise sharply. Similarly, the budget deficit seems bound to sail through the 3% barrier. In short, confrontations between Brussels and Rome seem inevitable .... the question is whether they could get so serious that an exit from the Euro by one of the linchpins of the whole European project becomes a genuine possibility. We wonder .... is it alarmist to think that they might, or complacent to think that they can't ?

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