"Meanwhile In Europe..." - The Big Day Arrives

Less than a month after the "shocking" election of Donald Trump as US president, the world prepares for another day of political shockwaves, this time out of Europe, when on Sunday all eyes will be on Italy and, to a slightly lesser extent, Austria.

Or, as Bank of America puts it "Meanwhile in Europe..."


As we have previewed on various occasions (most recently in Friday's extensive "Everything You Need To Know About The Italian Referendum & Should Be Afraid To Ask"), in a few short hours, Italy will vote on a constitutional reform referendum. While we urge readers to skim the in depth "walk thru", here is a simplified version of what happens after the likely "No" vote tomorrow.


The main concern in the markets - which has manifested itself in both the European currency, its vol structure, as well as Italian bond yields - is that a strong “No” vote will cause Prime Minister Renzi to resign, leading to political instability in Italy. Furthermore, a "No" vote is expected to kill a long-running attempt to rescue Italy's third largest and oldest bank, Monte dei Paschi, which has been desperate for a private sector bailout ever since it failed this summer's ECB stress test to avoid broader banking sector contagion; a failure of Monte Paschi will likely spark a fresh eurozone banking crisis, and prompt the ECB to get involved again (as it warned it would do), in a redux of what happened after the Brexit vote.

Also on Sunday, there is also a presidential election in Austria. A victory by the right-wing candidate, Norbert Hofer, would raise concerns about EU fragmentation because his party has advocated a referendum on EU membership. His victory would also raise concerns about a similar outcome in the French elections in May, and many other upcoming European elections as shown in the calendar at the bottom of this page:

However, while the Austrian vote will again be down to the wire - and since this time there won't be any Brussels-endorsed "widespread voting fraud", Norbert Hofer is assured to win - the key event will be the Italian vote. Here is what to expect in terms of timing:

  • Provisional turnout results from 7pm GMT (2pm ET)
  • Exit polls then expected around 10pm GMT on Sunday night (5pm ET)
  • First projections by Italian pollsters based on counted votes at around 10.45pm GMT (5:45pm ET)
  • Final result will come in around 2am on Monday (9:00pm ET)

In the highly improbably event the "Yes" vote wins, Deutsche Bank analysts write that a rebound in the Italian equity market should be largely restricted to financial stocks. Although the FTSE MIB is trading at a 15% discount relative to its 10-year average vs. Europe, valuations look substantially less attractive once banks are excluded from the index. The relative P/E of the FTSE MIB ex banks is trading in line with its long-term average vs. Europe ex banks. Several Italian sectors are even trading at a premium vs. their European peers, showing no signs yet of a spillover of banking sector risks.

That may change in just a few hours.

The biggest question from tomorrow's vote, is what happens to Italian PM Renzi should he lose the vote, and as France 24 reports, if voters reject Renzi's plan to streamline parliament, the centre-left leader has said he will step down.

The self-styled outsider in a hurry to shake up Italy finds himself on the inside, a target for those who say he has not been quick enough in fixing long-standing problems. For those unfamiliar, here is a brief snapshot of Renzi's approach, and political options:

After rapid rise, Italy's Renzi braced for fall

 

Renzi was just 39 when he came to power via an internal party coup in February 2014. With his penchant for retro sunglasses, open-necked shirts and jeans, the former mayor of Florence was hailed at the time as a premier for the smartphone generation. But the breath of fresh air is now in danger of being blown away by rival young Turks from populist and far right opposition parties trying to force him out.

 

After 1,000 days in office, Renzi, now 41, boasted last month of having steered the economy out of recession, got Italians spending again and improved public finances. He has also had significant political victories: a controversial Jobs Act passed, election rules rewritten and his candidate, Sergio Mattarella, installed as president.

 

As his Twitter follower numbers rose, so too did his international profile. Renzi was feted for his reform efforts by US President Barack Obama and German Chancellor Angela Merkel. "Matteo has the right approach and it is beginning to show results," Obama said just before treating Renzi and his school teacher wife Agnese to the last official White House dinner of his administration in October.

But many Italian voters do not share Obama's optimism. As the recovery has struggled to gain traction -- leaving unemployment stubbornly high, particularly among young people -- Renzi's ratings have slipped.

 

The Jobs Act, which eased hiring and firing, made him business friends but alienated trade unions and the left. A bullish style that was once seen as energetic has come to be viewed by some as high-handed, including by some grandees of his own party. Former Prime Minister Massimo d'Alema, a fervent critic of Renzi's constitutional proposals, described his successor to the New York Times as a Twitter-obsessed "oaf". The decline in Renzi's popularity is relative however. Polls suggest the Democratic Party, under his leadership, would top an election held tomorrow, albeit only just.

 

Born on January 11, 1975 in Florence, Renzi studied law and took his first steps in politics as a teenage campaign volunteer for future prime minister and European Commission chief Romano Prodi. By 26 he was a full-time organiser for La Margherita (The Daisy), a short-lived centre-left party.

 

He was only 29 when he became the leader of the province of Florence in 2004, establishing a power base that enabled him to go on to become mayor in 2009 and prime minister five years later. But for a brief spell in his early 20s working for the family advertising business, politics is all he has done and friends say he would be loath to give it up, despite his protestations to the contrary.

Even if has to make way as premier, he is not expected to give up the party leadership.

In short, Renzi is still very young, and a failure tomorrow followed by a resignation, means merely a detour for the career politican, not an end. The bigger question, however, is whether Italy is stable enough and its banks solid enough to survive a politidal vacuum wthout a "technocratic" government ready to step in and fill the void. The answer may be revealed as soon as Sunday night when the Euro opens for trading.

* * *

There is more to come.

As Bank of America notes, the common thread in all of these stories is that politics is driving economic outcomes. This dynamic will not change anytime soon, and BofA notes that it is "particularly concerned about the  drift toward protectionism." The bank notes that the number of trade restrictions globally has already picked up. Data from Global Trade Alert, a group of academic economists, shows an increase in the number of protectionist measures starting in 2012 and accelerating sharply in 2015. These include not just tariffs and quotas, but a range of policies that give  preference to domestic over foreign products.

An Italian "No" vote simply accelerate the global backlash against globalization, and lead to even more trade protectionist measures. But what is the most likely outcome, is that when the "No" vote wins (despite the endorsement of The Economist, which has gotten the outcome of every major political event this year wrong), it will only push the case for the anti-establishment vote in more European countries, until eventually Europe's populist forces stretch the European experiment so thin, that the Eurozone itself - an experiment which from day one catered to corporate interests and an established political oligarchy - will collapse under the weight of its own discontents.

For now, we await the surge in volatility that will emerge tomorrow afternoon, only to mysteriously disappear as every central bank around the globe engages in another BTFD orgy, sending risk assets higher even as the rapidly "isolating" world teeters on the verge of globalized collapse.

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