Until Trump's Thursday trade war announcement, and last night's shock statement by Kuroda previewing the end of the BOJ's QE, the single biggest event risk was the Italian election this Sunday, March 4 (together with the SPD "grand coalition" referendum held concurrently in Germany whose outcome could seal Merkel's fate).
And yet, ahead of the election, investors are feeling especially complacent, with no notable moves in terms of Italy-specific risk assets because, as Reuters noted, "the economy is strengthening and anti-euro sentiment is waning in the single-currency bloc" although many beg to differ. Still, the vote has the potential to throw them a curve ball.
Below we comment on some of the key questions surrounding of the election.
First, the basics:
- The Italian election takes place Sunday, March 4. Polls will be open from 06:00 GMT to 22:00 GMT. As results filter through from 22:00 GMT / 17:00 EST Sunday, the most contentious seats are considered in the south.
- The election will elect the 945 members of the parliament for the 18th legislature – specifically, to select the 630 members of the Camera dei Deputati (lower chamber) and 315 of the Camera del Senato (the Senate/upper house). Note that the electorate does not vote for the PM.
- The main parties in contention are:
- Forza Italia (center-right) led by former PM Silvio Berlusconi
- Democratic Party (center-left, PD) led by former PM Matteo Renzi
- 5 Star Movement (anti-establishment, M5S) led by Luigi Di Maio – seen as the most market negative outcome.
What are the expectations?
- Reuters has put together a useful poll tracker which can be found at the following website.
- No single party or coalition is expected to reach a parliamentary majority thanks to the new electoral law (see below). For example, Bloomberg surveyed 15 economists on February 2-7, with 38% expecting a hung parliament, and 33% a grand coalition:
What is the most likely outcome?
- Latest polls point to a hung parliament, where no one party or coalition has a majority to form a government. If this happens, Italian President Sergio Mattarella, will call on parties to form a broader coalition of pre-election adversaries. This could include the ruling centre-left Democratic Party and Silvio Berlusconi's Forza Italia.
- Analysts see a hung parliament, leading to a broad coalition that includes mainstream parties, as the most positive market outcome because it could result in political stability and policy continuity on Europe. Even in this situation, any uncertainty over the government's make-up could lead to short-term volatility.
- While unlikely, the most feasible coalition would be center-right (CR), given that M5S has ruled out a coalition. A CR coalition would be formed by Forza Italia, Lega Nord (the anti-south, anti-immigrant Northern League), Fratelli d'Italia (Brothers of Italy) and Noi con l'Italia (Us with Italy).
- All the polls show the Five Star Movement (M5S) as becoming the single largest party, winning between 27% and 29% of the vote. However risks for EUR have diminished since the party dropped its call for a referendum on the euro in mid-January. A (market positive) surprise would be an outright center-right victory.
Will the winner tackle Italy's giant debt pile?
- Reuters here is laconic: "Probably not."
- Whatever Italy's next government looks like, the chances that it will push through long-term term structural reforms to improve Italy's economic performance or to tackle the country's debt pile, are low. At 132% of GDP, Italy has the European Union's worst debt ratio after Greece.
- In fact election pledges could worsen the situation - Bank of Italy Governor Ignazio Visco has cautioned that parties' pledges to slash taxes and hike spending could prove counterproductive since the problem of high debt "cannot be sidestepped." That could increasingly bring investors to view Italy as the euro zone's weak link, making Italian assets vulnerable at times of market uncertainty or during the withdrawal of European Central Bank stimulus.
What could surprise markets?
- As a reminder, this is the first election to take place under a new, untested voting system introduced last year, which makes the outcome particularly uncertain. It is possible that a coalition of centre-right parties, leading in the polls, will win a majority of its own.
- One surprise would be a centre-right victory, with the eurosceptic League as the biggest party, possibly enabling its leader to become prime minister. Success for the League, which calls the euro a "failed currency," could revive euro break-up fears and widen the gap between Italian and German bond yields.
- An election outcome that allows the League or the anti-establishment 5-Star Movement to have a central role in government may have the same effect. And if a government is not formed, fresh elections cannot be ruled out
Surprise No. 1: The new electoral law
- One reason why there is elevated uncertainty around Sunday’s election is the newly-approved electoral law called Rosatellum Bis. The new system makes seat projections very difficult and throws historical lessons out of the window.
- 2/3 of seats are elected under a proportional voting system and the remaining 1/3 elected in a ‘first-past-the-post’ electoral system – this favors the most prominent people in the parties seats in Parliament, and thus has been criticized by the M5S.
- Each party needs to get at least 3% of votes in both chambers to get into parliament, while coalitions need 10%.
Surprise No. 2: Uncertainty!
- The high number of undecided voters means that polls and projections have to be taken with a pinch of salt. Politico cites recent polls as saying as much as 30-45%of the electorate is undecided.
- “Around 10mn Italians haven’t decided yet if they will vote and for whom,” Antonio Noto, head of the IPR polling agency said. “That means that the result may change in a substantial way in the last few days before the vote.”
- Some political commentators have also suggested that tactical voting may be at play – given the PD are expected to be defeated, we may see center-left voting to block M5S.
What about Germany's SPD ballot results?
- A "thumbs-up" for Germany's coalition deal will suggest modest fiscal expansion, adding in turn to better growth and higher inflation. That could hasten the end of the cheap-money era and keep upward pressure on borrowing costs. If Italy's election too passes without major ructions, it will remove a layer of political risk from the calendar and reinforce the case for unwinding ECB stimulus.
- Focus can then turn to the next ECB chief, a post that changes hands next year. While speculation is of a German - possibly the hawkish Bundesbank chief Jens Weidmann - taking the reins after the departure of "southerner" Mario Draghi - Germany's Social Democrats say they have not discussed backing Weidmann for the role.
- But any negative surprise outcome from Italy or Germany could encourage the ECB to keep asset purchases in place beyond their September end-date, in turn prompting investors to rethink the timing of rate rises.
Does EUR care?
- Last Friday a Citi spot EUR trader noted: “I still find the whole Italian election fascinating. No one is talking about it (they shouldn’t), but inside everyone is holding back a little bit (they shouldn’t).”
- To the point, Citi's options desk noted "something remarkable" about the Italian election: the main characteristic of this event is the lack of significant flows in the short dates. Event variance is stable and this chart below from Bloomberg is a case in point.
Bottom line: unlike the much more "exciting" French election last year, the Italian election is not a simple one-off event risk for EUR – "it is not a binary event where one result is market positive, the other negative" as Citi puts it. The most likely outcome is that the prolonged period of coalition talks after the election will play out much like the German elections; as a reminder, after the hung parliament in the 2013 election, it took 62 days to elect a government.
In other words, Sunday's event, absent a major surprise, will mean auto-pilot continuity for Italy, and Europe.