The result of the Italian election on March 4 proves once again that populism is alive and well in Europe.
In this election, the political centre in Italy got hollowed out even more, as parties from the extreme ends of the political spectrum made large gains.
We expect a grand coalition to emerge, although the exact constituents of that remain to be seen.
It seems likely that more right-wing parties will have greater power and more share of voice in Parliament going forward. Importantly, these more right-wing parties are in favour of more fiscal spending. With Italy’s debt-to-gross domestic product (GDP) still quite high, this could be potentially negative for the economy and we could see Italian bonds underperform.
The market is trying to price in the possibility that things could get shaken up a bit more in Italy as parties traditionally on the fringe have gained more ground.
However, we are unlikely to get a clearer picture on how the new Parliament will look for many weeks, which means increased uncertainty for Italy in the short term. Increased uncertainty could lead to bouts of volatility in Italian bonds over the coming weeks.
The resignation of former Prime Minister Matteo Renzi as leader of Partito Democratico (PD) opens the possibility of PD teaming up with its old foe, the left-leaning Five Star Movement, to try to form a government.
In my view, that’s the outcome most likely to be received positively by European bond markets.
But that’s not the only option. A slightly less-attractive prospect for European bond markets would be for PD to join the centre-right coalition, which includes Forza Italia and the populist Liga.
From a fixed income market perspective, the most negative outcome would seem to be a tie-up between Five Star and Liga, both of which won a substantial number of seats but which have little in common except their opposition to the European Union (EU).
Recently, both parties have dialled-down their anti-EU rhetoric and are unlikely to want to leave the EU, so we do not see it as a systemic issue for the rest of the EU. This is strengthened further by Germany’s coalition agreement over the first weekend in March, and Germany thus remains a strong advocate for the wider EU project. We think events in Germany somewhat offsets any potential for increased anti-EU sentiment in Italy.
We are still optimistic about Italy’s long-term fundamentals. But the political trajectory of the country is a concern, particularly the push for increased fiscal spending by the increasingly more powerful right-wing parties. We are in wait-and-see mode on Italy at the moment, and we will likely wait to see what happens in Italy before reassessing our positioning.
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