The results of elections in Italy could signal a return to uncertainty for the European Union as Italian voters favoured two anti-establishment parties, the Five Star Movement (M5S) and the Northern League, in a outcome that failed to provide any party with the majority needed to govern.
The Eurosceptic Five Star Movement led at the ballot boxes, picking up approximately a third of the vote.
The FTSE MIB Index – the most widely followed benchmark for the Italian equity market – opened 1.8% down on Monday 5 March 2018 as projections pointed to a hung parliament.
The FTSE MIB Banks Index, which measures the performance of the banking sector, displayed a 2.3% decrease from the previous close.
The equity market drop at market open led to paper losses in ETFs tracking the FTSE MIB Index, such as the $780m Lyxor FTSE MIB UCITS ETF (MIBX LN) and the $370m iShares FTSE MIB UCITS ETF (IMIB LN); however, most of these loses were recouped as markets pared losses.
Reactions were equally subdued in the bond markets, with 10-year Italian BTPs yield barely 3.8 basis points higher than Friday’s close at 2.01%. This led to minor losses in the $660m iShares Italy Govt Bond UCITS ETF (SITB LN). SITB tracks the Bloomberg Barclays Euro Aggregate Treasury Italy Index, consisting of Italian government debt – currently rated BBB – from across the maturity spectrum. Following the election results, spreads over German debt moved only 5.4bps higher at 138.0bps.
What follows could be days or weeks of negotiations due to a myriad of potential political alliances that could result in a coalition government. While the Eurosceptic Five Star Movement led at the ballot boxes, picking up approximately a third of the vote, the Northern League has claimed the result shows it has the support of the people.
An alliance between the League and the Forza Italia party would be the most realistic duo that picks up the most seats in parliament but it is yet unclear whether leader, and former Prime Minister, Silvio Berlusconi, is willing to jump into bed with such a far-right party, especially as junior partner.
Meanwhile, Matteo Renzi, former Prime Minister and head of the centre-left Democratic Party going into these elections, has already tendered his resignation as leader after failing to pick up a fifth of the vote.
Although unlikely, the worst case for the EU would likely be an alliance between M5S and the League, handing a strong majority to a coalition of populist, anti-establishment parties with agenda of swift immigration controls and even potential secession from the EU.
ETF issuers offered their take on the election results.
Aneeka Gupta, Equity & Commodity Strategist at ETF Securities, said, “The overall reaction to the Italian elections has been sanguine in the bond and equity markets. This is partly because the outcome of a hung parliament had been priced in and the market seems distracted by the ongoing trade wars sparked by President Trump. Italian bond yield spreads over Germany have widened marginally above the prior week’s level to 210 bps. Italian banking stocks have felt the greatest impact on the downside owing to its high domestic exposure. Credit default spreads of Italian banks have spiked 7.68% due to the lack of certainty surrounding the election outcome. We see this an opportunity to buy on dips, as Luigi Di Maio, leader of the M5S has previously outlined his intention to make it easier for the country’s ailing banks to recover assets, allowing to maximize returns.”
Florian Ginez, European-based research analyst at WisdomTree, commented, “With a hung parliament, Italy’s legislative engine is going to potentially be jammed for an extended period of time. In that set up, it is hard to see how Italy is going to take measures to significantly increase its primary budget and reduce its debt pile, currently standing at 132% of GDP. This sword of Damocles is a major issue for the country, as it as it dampens the government’s ability to react in case of a downturn.”
Ginez continued, “So what does the future looks like? With Italian unemployment at 11.1%, only 1.0% down from the broad Eurozone peak unemployment in July 2013 (both were at 12.1%, Eurozone is down 3.5% to 8.6%), political parties have to cope with the Italian people’s discontentment. So whether some form of coalition, or a new election emerges, promises will still be made to cut taxes, increase spending, and improve welfare and pensions. No doubt this will feed discussions around the potential appetite and fundamentals of Italian debt for some time to come.”
Antoine Lesné, head of EMEA strategy and research for SPDR ETFs, part of State Street Global Advisors, noted, “Political risk is back roaring. Italy was always going to be the country where some of the Eurozone construction issues would be the most acute. Despite the recent toning down of anti-euro rhetoric, this is a blow to the strong consensus that the common currency has been enjoying of late. It may still be too soon to expand into another full blown Eurozone crisis and the market will have to analyse the impact of this election on actual reforms. But the word is out and Italian treasury spreads will widen from current levels while the euro strength could be halted until more clarity comes to light. This may also inevitably reverberate onto other euro assets at least until the market focuses on the next important European event this week, namely the European Central Bank.”
Just as the establishment had begun to breathe a bit easier, having seen off populist movements in France, The Netherlands, Austria and Germany, the election results in Italy have certainly put political risk back on the table.