An Italian election is an event which has the potential to shock the financial markets and investors have not paid much attention to this event just yet. There have been dozens of violent political protests around Italy and protesters have rocked the streets as Italians prepare to go to the polls. Italians will vote on the future of their country on the 4th of March. Clashes between anti-fascist activists and supporters of anti-immigrant and populist parties are breaking out in different cities of Italy. The differences are vast between North and South and there seems to be no clear policy by any party to tackle them.
The biggest surprise in the market is always when investors are not prepared for something. Since the French elections, investors are largely in the mind frame that the Eurozone is not going to break any further, hence they are not looking at this as a major risk. Looking at the Italian equity markets or economic indicators which shows 14 straight quarters of economic growth, Italians are still not feeling the impact of this growth. The country’s economy is still six times smaller if we compare it to the size seen in 2008. A massive mountain of debt and stifling bureaucracy, have pushed millions of Italians into poverty. Anti-immigrant parties and the rise of populists such as the far-right anti-immigrant League and the 5-star movement parties would only make matters more difficult.
We do think the below are some critical points which one should keep in mind;
- Italian parliament election one week away and the polls do not show any clear majority. The Euro and the stock markets could see massive moves. Investors could expect the spread between Italian and French 10-year bond, and the spread between Italian and German 10-year bond widen.
- Any uncertainty around Italian government could present a risk for the FTSE MIB and for the Euro. The Italian equity market could see a large correction if we have unfavourable results or even a hung parliament.
- There has been a very little progress on the structural reform front and this remains a major concern
- The new government could inflate the public spending to make themselves more popular, but without any firm plan to control the country's debt would mean more trouble in the future
- The ECB is about to finish its bond purchase program and in the absence of any plan, the bond yields on the Italian 10 and 5 notes could rise significantly.
- Slow economic growth and issues in the banking system would make the picture ugly in the future. Which could raise the yield more than 100 basis points. The average is 2.8%.
The below charts for the Euro and Stoxx 50, shows the current trend. The euro is looking strong and a more favourable result could push the euro higher. The STOXX50 index has broken its upward trend line, but the recent momentum is controlled by the bulls. If the results are unfavourable, one could expect heavy sell off for the equity market.
