Italy voted “no” in yesterday’s Referendum, rejecting Prime Minister Renzi’s proposed changes connected to the electoral reform.
This outcome will bring, in our view, a phase of relative uncertainty, with Renzi’s resignation announced last night and the possible formation of a technical government to renegotiate the electoral law and re-boost reform momentum. Italy will enter this critical period with an electoral law applicable only to the Deputies Chamber and still under scrutiny by the Constitutional Court.
With Renzi’s resignation, multiple scenarios are now possible: Italian Republic’s President Mattarella could give the mandate to form a new Government to Renzi himself or, more likely, due to the broad electoral result, to some respected technocrat – economics minister Padoan could be a possibility.
The priority of this
transition Government would be to review the electoral law and to push reforms in continuation with Renzi’s legislature. Early elections cannot be excluded but are not our central case.
Looking at the economic impacts of this result, Renzi’s resignation could halt efforts taken in recent years to stimulate the Italian economy. We will likely see some pressure on the Italian banking sector. If a Government is rapidly formed, those risks could be well contained and we could see the legislation process continuing with some sort of coalition Government.
Uncertainty instead would ramp up if early elections are called and anti-establishment and euro-sceptical parties triumph. We believe that this scenario, which could potentially bring back the euro break-up debate, is unlikely, as parties have strong incentives to form a coalition and complete the electoral law before an election. Also the Constitution court is likely to demand changes to make the system more proportional.
From a broader perspective, the referendum outcome confirms a changing political landscape in Europe and the US. Next year will bring elections in Germany, France and the Netherlands, at a time when the aftermath of Brexit is still unfolding, as well as the changing equilibria associated with Trump’s election.
These events come at a time when Central Banks are passing the relay baton back to Governments in an effort to complement monetary policy stimulus with more expansionary fiscal policies and structural reforms. Populism and rising social discontent remain the key risks, but we believe that expecting a materialization of these risks on the back of the “no” victory is overstated. The outcome of future political elections may be a more relevant factor, likely to shape the fiscal policy stance, and ultimately having an influence on Central Banks’ monetary policy.
From a fixed income perspective, a “no” victory was partially discounted in Italian assets, and we believe there is value in Italian government bonds. We expect volatility in the short term and the ECB to be ready to frontload purchases of BTPs. What is not priced in is prolonged political instability: the inability to form a caretaker government, an early election with the current electoral law, the risk of 5 Star winning it and then pushing for a referendum to leave the euro. But we consider this scenario unlikely – even in the case of an early election, 5 Star should not win the majority in both houses as they will likely win only a third of the seats in the Senate (which is still elected under a standard proportional system).
From a multi-asset perspective, we favour keeping a cautious view on European equities, preferring domestic, investment grade credit on short-term maturities. The headline risks of the crowded political calendar are tangible and the political paralysis which could result from the success of populist movements remains a reason for concern. The broad reflationary environment, so far, is best reflected in US and Japanese equities, which could also benefit from national initiatives designed to support earnings growth. We maintain a dynamic approach to fixed income: within the theme of reflation, we like inflation-linked bonds in the US and Euroland, where we believe a very low inflation pattern is still priced-in.
Overall, we believe that this result will not derail our constructive outlook for 2017, with potentially higher growth and higher inflation, globally, on the radar.